Whether you have an IRA or 401(k) as your main retirement plan, you have two options when it comes to the types: traditional or Roth. Two of these types of retirement accounts are similar in nature but there are significant differences.
The differences are all about taxes and how the contributions are made. Regardless of person and amount of contribution, the contributions to a Roth 401(k) or IRA are made with after-tax dollars. What this means is that the contributions are taxed.
On the other hand, with traditional or other qualifying 401(k) or IRA, the contributions aren’t taxed. This is because contributions to these retirement accounts are made with pre-tax dollars. On top of this, you get to deduct your contributions to a traditional 401(k) or IRA. So, there is a double benefit to it as far as taxes are concerned.
Which retirement account is best for me?
Which one you should select depends on two major factors:
- how much you’re earning now
- how much you are going to earn in retirement
Most Americans earn and spend less in retirement. If that’s going to be the case for you—traditional 401(k) or IRA is going to benefit you at a larger scale. This is because you don’t pay taxes now but pay when making a withdrawal. Even if you have a million dollars on your retirement account, you won’t be taxed for the amount held in the account. Instead, you will be taxed for the amount withdrawn.
This is the opposite of Roth 401(k) and IRAs. Your contributions are taxed and added to your gross income for the tax year it was contributed but you won’t pay tax when you get to use it.
Figuring out which is best for you
Having said that, which retirement account is the best for you comes down to the things mentioned above. Select wisely because you may get to lose thousands of dollars in the process—not as a direct loss but as means to choosing the wrong retirement account type.
Luckily, you have the option to transition your retirement account from traditional to Roth. This can be done both for 401(k) and IRA. So, opening a traditional retirement account is going to be the safest if you can’t decide for now.