Traditional vs Roth1
Summary
TLDRIn 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.
Outlines
💼 Types of Retirement Accounts: Pre-Tax vs. Roth
Clark Hayden from Lock, Shield Partners explains the two main types of retirement accounts: traditional or pre-tax accounts and Roth accounts. Traditional accounts include IRAs and employer-sponsored plans like 401K, 403b, and SEP IRA, allowing for tax deductions on contributions, but taxable withdrawals. An example illustrates how Bill, earning $50,000, would get a tax deduction for contributing $5,000 to a traditional IRA, reducing his taxable income. However, withdrawals are taxed, and there's a 10% penalty for early withdrawal before age 59 and a half. Roth accounts, on the other hand, do not offer tax deductions for contributions but allow tax-free growth and withdrawals, provided certain conditions are met. The choice between traditional and Roth accounts depends on the individual's financial situation and long-term goals.
Mindmap
Keywords
💡Financial Literacy
💡Retirement Accounts
💡Traditional or Pre-Tax Accounts
💡Tax Deduction
💡Taxable Distributions
💡Early Withdrawal Penalty
💡Roth Retirement Accounts
💡Tax-Free Growth
💡Liquidity
💡IRA (Individual Retirement Account)
💡401K
Highlights
Introduction to the video by Clark Hayden discussing retirement account types for long-term savings.
Two basic buckets of retirement accounts: traditional or pre-tax, and Roth.
Traditional retirement accounts include IRA, 401K, 403b, SIMPLE IRA, and SEP IRA.
Tax deduction for contributions in traditional accounts, with taxation upon withdrawal.
Example of Bill's income adjustment due to a pre-tax IRA contribution.
Tax implications of distributions from traditional accounts during Bill's retirement.
Penalty rules for early withdrawal from traditional accounts before age 59 and a half.
Introduction to Roth retirement accounts as an alternative to traditional accounts.
Roth accounts grow tax-free with no tax deduction for contributions.
Bill's tax return example with a Roth contribution versus a pre-tax contribution.
Tax-free growth and withdrawal of funds in Roth accounts.
Advantages of Roth accounts for young savers with long-term saving horizons.
Flexibility and liquidity provided by Roth accounts for long-term financial planning.
Comparison of Roth and traditional accounts for young savers starting out.
Recommendation for young savers to consider Roth accounts due to their benefits.
Emphasis on the importance of choosing the right retirement account type for individual financial goals.
Transcripts
hi there I'm Clark Hayden with lock
Shield partners for a second financial
literacy video and today we're going to
talk about the difference in types of
retirement accounts when it comes to
long-term savings there are two basic
buckets of retirement accounts that you
can save money in the first is called
traditional or pre-tax and this can be
an IRA which is an individual retirement
account or this can be within an
employer sponsored plan of which there
are many types 401K 403b simple IRA SEP
IRA those are just some of the different
types that you could participate in with
your
employer traditional or pre-tax
retirement accounts operate where you
receive a tax deduction when you make a
contribution and the money is taxable to
you when you take it out down the road
as an example let's assume that bill
makes $50,000 per year in he saves
$5,000 in a pre-tax or traditional
IRA that tax deduction shows up as
follows when Bill goes to file his taxes
instead of his income showing up as the
$50,000 salary that he actually made it
will show up as
$45,000 his income is going to be
deducted or lowered by that $5,000 that
he contributed to his retirement account
now the flip side for bill is that over
time as he continues to add to that
account as it continues to grow when he
takes distributions or in other words
when he takes money out of that account
in the future the money that he takes
out will be counted as income in the
year that he takes a distribution so if
Bill takes out a $10,000 distribution
from that account that $10,000 will show
up as income in the year that he takes
it out there are also specific rules for
a pre-tax or traditional retirement
account for when that money can be
received without incurring an additional
tax penalty if those funds are received
prior to your age 59 and a half without
a there are a few special circumstances
but most of the time if they're received
before age 59 and a half there's an
additional 10% penalty on top of the
normal taxation so pre-tax or
traditional that's bucket one bucket
number two is what's called a Roth
retirement account so just like the
traditional you can have a Roth IRA a
you can have a Roth 401k Roth 403b all
these different types of accounts you
can choose to make Roth contributions
inside of those accounts Roth accounts
are the opposite of the traditional
accounts that we just covered in a Roth
account there is no dis there is no
special tax incentive or tax deduction
when you make that contribution but the
money grows tax-free over time so let's
use the same example Bill makes $50,000
per year but Bill chooses to contribute
his $5,000 on a WTH basis instead of a
pre-tax basis when Bill goes to file his
tax return he'll still show $50,000 of
income instead of the 45 that he showed
in the pre-tax example the difference
for bill is that that money that is in
his Roth account is now going to grow
taxfree over time so whereas previously
under the pre-tax example when Bill
takes money out he has to pay taxes
under that Roth money he does not have
to pay taxes on that Roth money as long
as it stays in there for the specified
time frame for young savers who are just
starting out Roth based retirement
accounts are very very very difficult to
be they provide enormous flexibility and
liquidity down the road if you have
years and years of time to save money
you're almost certainly better to use a
Roth based account instead of a
traditional
account
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