Secondary Savings for Retirement-Individual Retirement Accounts (IRA's)

Secondary Savings for Retirement — Individual Retirement Accounts (IRAs) Roth IRA vs. Traditional IRA One of the most common questions I get as a financial advisor is whether a client should invest in a Roth IRA or a Traditional IRA. The answer: it depends. Probably not the answer you were hoping for, but before we get to a recommendation, let’s cover the basics of Individual Retirement Accounts (IRAs).

An IRA is an account dedicated to your retirement savings. It is in your name, and your name only. A spouse or another individual can be listed as a beneficiary, but the account itself belongs to one person. IRAs are designed to let you save additional money for retirement beyond what you contribute to a 401(k). You can also choose from a wide range of investment options — stocks, bonds, exchange-traded funds, and mutual funds — and you can manage the account yourself or hire a professional to do it for you, depending on your comfort level.

There are two main types of IRAs: Traditional and Roth. Traditional IRAs allow you to contribute pre-tax money. Once invested, earnings grow tax-deferred, and contributions may be tax-deductible depending on your income. When you retire and begin withdrawing, the money is taxed as ordinary income. Roth IRAs allow you to contribute after-tax money. Earnings grow tax-free, and contributions are not tax-deductible. Unlike a Traditional IRA, qualified withdrawals in retirement are entirely tax-free, with no tax liability on your gains. That can be a powerful way to reduce your tax obligations in retirement.

IRA contributions come with their own rules. For individuals under 50, the annual contribution limit is $6,000. If you’re 50 or older, the limit rises to $7,000 — the extra $1,000 is known as the catch-up contribution. (Note: these limits were in effect at the time of writing and have since changed; check current IRS guidance.) It’s also important to know that not all earners are eligible to contribute to a Roth IRA or to deduct Traditional IRA contributions. There are income phase-outs, which we’ll cover in a future article.

So what’s the right choice for you? Again, it depends. To get more concrete, look at your own financial picture and ask yourself: How much can I contribute?
Do I want to manage the account myself, or would I prefer professional management?
Do I need more tax deductions now?
Am I likely to pay more or less in taxes during retirement? Let’s walk through an example.

John is a 35-year-old software engineer. He earns $100,000 per year and contributes 10% of his salary to his 401(k). He’d like to save additional money for retirement and is interested in buying individual stocks. John doesn’t feel he needs more tax deductions — though he plans to confirm with his accountant — and he expects his tax rate to be higher in retirement than it is today.

What should John consider? A Roth IRA may be a suitable fit. He’s not focused on immediate tax deductions, and if he’ll pay higher taxes in retirement, paying taxes now means tax-free withdrawals later. All his gains would also be tax-free. Because John wants to buy individual stocks and manage his own portfolio, an IRA — which offers that flexibility — is a good match.

Saving for retirement can be challenging, and many people don’t realize that an IRA is completely separate from their employer’s plan. Contributing to both your 401(k) and an IRA gives you the best chance of hitting your retirement income goals. If you have questions about your financial picture, feel free to reach out to us for a consultation. Email us at team@cfefinances.com. As always, thanks for reading! CFEFinances.com