Traditional vs Roth1

Summary

In this financial literacy video, Clark Hayden from Lock, Shield Partners discusses two main types of retirement accounts: traditional pre-tax accounts, such as IRAs and 401Ks, which offer tax deductions now but tax the withdrawals later, and Roth accounts, which lack upfront tax incentives but allow tax-free growth and withdrawals. He emphasizes the importance of choosing the right account type based on one's financial situation and time horizon, highlighting the flexibility of Roth accounts for young savers.

Takeaways

• 💼 There are two main types of retirement accounts: traditional (pre-tax) and Roth (after-tax).
• 📋 Traditional retirement accounts include IRA, 401K, 403b, SIMPLE IRA, and SEP IRA.
• 💰 With traditional accounts, you receive a tax deduction for contributions, reducing your taxable income for the year.
• 💹 The money in traditional accounts grows tax-deferred, meaning you pay taxes when you withdraw funds in retirement.
• 🚫 Early withdrawal from traditional accounts before age 59.5 typically incurs a 10% penalty in addition to regular taxes, except under special circumstances.
• 🌱 Roth retirement accounts do not offer an upfront tax deduction for contributions.
• 🌳 The funds in Roth accounts grow tax-free, and qualified withdrawals are tax-free as well.
• 📈 For individuals starting to save early, Roth accounts offer significant flexibility and liquidity in the long run.
• 💡 The choice between traditional and Roth accounts should consider factors like current and future tax rates, retirement goals, and time horizon.
• 📊 Bill's example illustrates the difference in tax treatment between traditional and Roth accounts, highlighting the impact on income reporting and tax liabilities.
• 🏦 Both types of accounts can be part of an individual's retirement savings strategy, with each offering distinct advantages based on personal financial situations.

Q & A

What are the two basic types of retirement accounts mentioned in the video?

The two basic types of retirement accounts mentioned are traditional or pre-tax retirement accounts and Roth retirement accounts.

What is an example of a traditional or pre-tax retirement account?

Examples of traditional or pre-tax retirement accounts include IRA (Individual Retirement Account), 401K, 403b, SIMPLE IRA, and SEP IRA.

How does a tax deduction work with a traditional IRA?

With a traditional IRA, you receive a tax deduction when you make a contribution, which reduces your taxable income for the year.

Can you explain the example given for Bill's income tax deduction when he contributes to a traditional IRA?

If Bill makes $50,000 per year and contributes $5,000 to a traditional IRA, his taxable income will be reduced to $45,000 for that year.

What are the tax implications when distributions are taken from a traditional retirement account?

When distributions are taken from a traditional retirement account, the amount withdrawn is considered income and is taxed in the year it is received.

What is the penalty for withdrawing from a traditional retirement account before the age of 59 and a half?

If funds are withdrawn from a traditional retirement account before the age of 59 and a half, there is typically a 10% penalty in addition to normal taxation, unless special circumstances apply.

How does a Roth retirement account differ from a traditional one in terms of taxation?

A Roth retirement account does not offer a tax deduction for contributions, but the money grows tax-free, and qualified distributions are tax-free.

What is the main advantage of a Roth account for young savers who have many years until retirement?

The main advantage of a Roth account for young savers is the tax-free growth and tax-free qualified distributions, providing flexibility and liquidity in the long term.

Can you give an example of how Bill's tax return would differ if he contributed to a Roth account instead of a traditional one?

If Bill contributes to a Roth account, his taxable income on the tax return remains at $50,000, unlike the traditional IRA where it would be reduced by the contribution amount.

Why might a Roth-based retirement account be a better choice for someone just starting out with long-term savings?

A Roth-based retirement account is beneficial for those starting out because it offers tax-free growth and tax-free withdrawals after meeting certain conditions, which can be advantageous over a long period of saving.

What are some common types of employer-sponsored plans that can be traditional or Roth accounts?

Common types of employer-sponsored plans include 401K, 403b, and SIMPLE IRA, which can be structured as either traditional or Roth accounts.