Roth vs. Traditional Accounts for Pre-Retirees

As you inch closer to retirement, the question of maximizing your nest egg becomes paramount. While countless investment options exist, two titans stand out: Roth and Traditional accounts. But which one suits your needs? Worry not because this article will untangle the web and help you choose the path to a more secure retirement.

Understanding the Basics:

Traditional IRAs and employer-sponsored 401(k)s allow you to contribute pre-tax dollars, lowering your current taxable income. In simpler terms, you pay less tax now, but your contributions and any investment gains are taxed when you withdraw them in retirement. Think of it as borrowing tax-free from Uncle Sam, with interest due later.

Roth IRAs and Roth 401(k)s, on the other hand, require contributions from your already-taxed income. Yes, you pay taxes upfront, but your contributions and all future earnings grow tax-free, and qualified withdrawals in retirement are also tax-free. It’s like paying off a credit card in full – no future tax burdens!

Contribution Limits (2024):

Traditional and Roth IRAs: Both have a combined contribution limit of $6,500, increasing to $7,500 for those aged 50 or older.

401(k)s: The limit for employee contributions is $22,500, increasing to $27,000 for those aged 50 or older. Employers may also contribute, further boosting your retirement savings.

Income Restrictions (2024):

Traditional IRAs: No income restrictions for contributions, but deductibility phases out for higher earners.

Roth IRAs: Phase-out for contributions starts at $129,000 Modified Adjusted Gross Income (MAGI) for single filers and $218,000 for married filers filing jointly. Above these thresholds, contributions are phased out completely.

Note: MAGI is essentially your Adjusted Gross Income (AGI) plus certain additional income and deductions. This includes items like student loan interest, qualified education expenses, and IRA contributions themselves. So, while your Roth contributions might lower your AGI, adding back that contribution to your MAGI creates a more accurate picture of your overall financial state for tax purposes.

Deciding Your Destiny:

Tax Brackets: Consider your current and expected future tax brackets. If you expect to be in a lower tax bracket in retirement, a Traditional account might be more tax-advantageous. However, if you expect to be in a higher bracket, a Roth account could shield your future income from taxes.

Time Horizon: Roth accounts shine for long-term investments, as tax-free growth compounds significantly over time. Traditional accounts might be better for short-term needs, as you can access contributions without penalty after age 59½.

Flexibility: Traditional accounts offer more withdrawal flexibility, allowing penalty-free access to contributions after age 59½ (early withdrawal penalties may apply). Roth accounts offer penalty-free access to contributions at any time and qualified distributions after age 59½.

Remember: This is just a starting point. Consulting with a Retirement Risk Advisor can help you create a personalized plan that aligns with your unique circumstances and goals.

Not sure where to start?

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