When you think about what financial goals are most important to you, retirement is probably near the top of your list. You may already be asking yourself, “When can I retire?” or “How much do I need to retire?” Not to mention the hundreds of other questions that may come up in the process. Comprehensive retirement planning can help you feel more prepared for the future so that you can enjoy the present. Early retirement can provide many other benefits, such as reducing the stress of everyday life and being able to enjoy spending more time with loved ones.
Fortunately, there are many financial tools available that can help you save for and secure your golden years. As you begin to plan for the future, it’s important to carefully look at these instruments, which may be able to provide you with financial security, more tax advantages, and priceless peace of mind. Our fee-only CERTIFIED FINANCIAL PLANNER™ professionals are going to walk you through several types of individual retirement accounts (IRAs) and which may be beneficial to you.
Roth IRA vs Traditional IRA: What’s The Difference?
Created in 1974, the traditional IRA is a tax-advantaged savings vehicle designed for long-term investments, with a special eye toward retirement. The traditional IRA allows investors to deposit tax-deductible money into their retirement savings account. This lowers the adjusted gross income for the year, easing your tax burden and allowing for compound interest to begin accruing immediately. When money is withdrawn in retirement, the deferred income tax on that money will come due, as well as the capital gains tax on the growth of the funds in the account.
While the Roth IRA works very similarly, the tax burden is reversed. With a Roth IRA, money is taxed as income in the year it is earned. The investor then contributes to the Roth IRA and leaves the money in the account until retirement. Then, in retirement, he or she will finally reap the reward for their patience. The money in their Roth IRA will be untaxed upon withdrawal – available with no additional income tax burden, no tax rate adjustments over time, and no capital gains tax.
Is a Roth IRA Right For Me?
A Roth IRA can be a powerful tool for retirement and legacy planning. As with any financial instrument that offers tax advantages, it does come with specific rules and limitations. With this in mind, it’s important to understand all the details before starting your own account.
What Are the Advantages of a Roth IRA?
No Required Minimum Distributions (RMDs)
When referencing an IRA account, withdrawals are most commonly called “distributions.” Traditional IRAs require minimum distributions starting at age 72, whereas a Roth IRA never requires you to withdraw any distributions. The money is available when you need it, and it will continue to accrue interest until then. If your account is left to your beneficiaries, then they will also be able to withdraw the remaining balance without any income tax penalties. This makes the Roth IRA another great legacy planning vehicle. Keep in mind that, traditionally, legacy planning refers to a financial strategy that helps people prepare to pass on their assets to loved ones after death. At Morris Financial Concepts, we believe that your legacy is created every day, not simply when you pass away. Our retirement planning experts provide holistic strategies so that you can live the life you want to the fullest while ensuring that your loved ones will be taken care of.
Since you will have already paid the relevant income tax on your Roth IRA contributions, that money is available to be withdrawn at any time, without penalty. With a Roth IRA, it is best to leave earned money in the account to compound and accrue until retirement, as the tax liability for withdrawing interest earnings from the account can be somewhat more complicated. In general, earnings can be withdrawn without penalty so long as you are over the age of 59½, and have held the Roth IRA account for more than five years. If you are under the age of 59½ and/or have not held the Roth IRA account for more than five years, interest can be withdrawn from the account at the normal capital gains tax rate, plus a 10% penalty fee. Exceptions may be made in certain circumstances, including disability, college expenses, birth and adoption expenses, or the purchase of a first home.
No Employer Plan Dependence
A Roth IRA is an independent account designed for personal retirement savings. It is unaffected by and unrelated to your 401(k), 403(b), or any other retirement plans offered through your employer. It can be considered in addition to, or as an alternative to, an employer-based retirement savings option. This flexibility allows the Roth IRA to be utilized as either a retirement plan, a legacy planning tool or both.
What Are the Disadvantages of a Roth IRA?
Income-Eligibility and Contribution Restrictions
As of 2021, the Roth IRA is only available to individuals with a Modified Adjusted Gross Income (MAGI) of less than $140,000 per year, with contributions phasing out at $125,000, or married couples making less than $208,000, with contributions phasing out at $198,000. Individuals that exceed these income limits are not eligible for Roth IRA contributions. Instead, they may still be eligible for a traditional IRA. Additionally, you may contribute up to $6,000 per year, for as many years as you like. After the age of 50, this limit goes up to $7,000 per year. There are no age limits; you may start saving as early or as late as you desire, although, the financial advantages are greatest if you start as soon as possible.
Is a Traditional IRA Right For Me?
A traditional IRA can be another great way to get a start with your retirement planning. The tax advantages can be immediate, and there are fewer income restrictions than the Roth IRA. To make a knowledgeable decision, you should understand the traditional IRA, too.
What Are the Advantages of a Traditional IRA?
No Income-Eligibility Restrictions
If your yearly income exceeds the $140,000 MAGI limit for the Roth IRA, you may still be able to take advantage of the traditional IRA’s tax deferral. There is no income limit for a traditional IRA account. The contribution limit between all IRA accounts is $6,000 per year, though you may distribute those savings between a Roth and a traditional IRA account if you so desire. A retirement planning professional, like those at Morris Financial Concepts, can help you determine the best savings portfolio for your financial situation.
Tax Deductions and Deferral
The traditional IRA allows you to deduct your retirement savings from your income before your Modified Adjusted Gross Income is calculated. This may allow you to take advantage of a lower tax bracket in the short term while building your nest egg for the future. While you will be required to pay taxes on the money when you take distributions in retirement, the traditional IRA can be a great way for young investors to begin saving, without being penalized for doing so.
What Are the Disadvantages of a Traditional IRA?
While anyone can start a traditional IRA account, other retirement instruments may affect the associated tax breaks. 401(k) and employer-based retirement plans can limit an investor’s ability to take advantage of the tax deduction. As of 2021, individuals with another retirement plan and $66,000 MAGI or less may fully deduct their traditional IRA contributions. Individuals between $66,000 and $76,000 may partially deduct their traditional IRA savings, while those over $76,000 who also have an employer-based retirement plan will see no tax benefits.
Distribution Restrictions and Requirements
Like a Roth IRA, a traditional IRA investor may begin taking distributions without suffering any tax penalties at the age of 59½. Unlike the Roth IRA, traditional IRAs require that you begin taking distributions at the age of 72. The amount withdrawn is calculated by dividing the account balance by your estimated life expectancy, as delineated in the IRS’s Uniform Lifetime Table. Consequently, the traditional IRA is more specifically calibrated for retirement saving, rather than legacy planning.
The Bottom Line
You may contribute up to $6,000 per year to either a traditional IRA, a Roth IRA, or both. These tax-advantaged dollars can be valuable assets and should be carefully considered when retirement planning. The Charleston, SC community, as well as our global clientele base, has trusted their finances to Morris Financial Concepts for more than thirty years. We offer holistic strategies and personalized financial counsel to help you achieve your unique retirement goals.
The opinions expressed herein are those of Morris Financial Concepts, Inc. (“MFC”) and are subject to change without notice. This material is for informational purposes only and should not be considered investment advice. All investing involves risk, including the possible loss of money you invest, and past performance does not guarantee future results. MFC relies on information from various sources believed to be reliable, including third parties, but cannot guarantee the accuracy and completeness of any third-party information. MFC is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about MFC including our investment strategies, fees, and objectives can be found in our ADV Part 2, which is available upon request. Certified Financial Planners TM (CFP®) are licensed by the CFP® Board to use the CFP® mark. CFP® certification requirements include: Bachelor’s degree from an accredited college or university, completion of the financial planning education requirements set by the CFP® Board (www.cfp.net), successful completion of the CFP® Certification Exam, comprised of two three-hour sessions, experience requirement: 6,000 hours of professional experience related to the financial planning process, or 4,000 hours of Apprenticeship experience that meets additional requirements, successfully pass the Candidate Fitness Standards and background check, agree annually to be bound by CFP® Board’s Standards of Professional Conduct, and complete 30 hours of continuing education every two years, including two hours on the Code of Ethics and Standards of Professional Conduct. MFC-21-05.