Both 401(k)s and Individual Retirement Accounts (IRAs) have traditional and Roth options. If you’re unsure on what 401(k)s and IRAs are, check out this article.
For traditional and Roth accounts, the difference all comes down to taxes and when you pay them. With a traditional account, the investor (generally your employer) takes a set amount out of your paycheck before it’s taxed and puts it into the retirement account. If you are contributing yourself, you will have already paid taxes on that money throughout the year, but that set amount will be deducted from your taxable income when you file. This way your retirement savings grow tax deferred. Basically, you don’t pay taxes on what you put in now, but you’ll have to pay taxes on what you take out later. This is useful if you have a higher income because you put off paying these taxes until you’re retired and likely in a much lower tax bracket.
A Roth works in the opposite way. With a Roth retirement account, you pay taxes on your contributions now, so you don’t pay taxes on your withdrawals later. This can be great if you currently have a lower income that you expect to average. For example, if you are early on in your career, you probably have a fairly low salary compared to what you hope to make in the middle of your career. That lower income means that you will fall into a lower tax bracket, so you would pay less in taxes now than you would later. Roth accounts also allow for withdrawals for things like first-time home purchases, qualified education expenses, expenses related to a birth or adoption, and other life events.
If you are interested in learning more about traditional or Roth IRAs, set up an appointment here to talk with an expert.
