Saving for retirement often requires the structure of long-term planning: strategies that will allow you to make the most of your savings while utilizing tax advantages. This kind of framework is taken care of by IRAs, or Individual Retirement Accounts. An IRA is a form of retirement plan that provides tax advantages for retirement savings, giving savers the economic benefits that will allow them to reach their saving goals efficiently.
What are Traditional IRAs?
When deciding on retirement plans, it’s important to consider the different types of IRAs available. Firstly, there is the option of a traditional IRA, which offers tax advantages and deductions to savers. If you qualify for this kind of tax deduction, your IRA contributions are deducted in the year they are made. This immediate action makes traditional IRAs particularly appealing for those who want to reduce their tax bills without delay.
What are Roth IRAs?
Alternatively, you have the choice of a Roth IRA, which offers you opposite benefits from a traditional IRA. This kind of account does not include an immediate tax deduction when you make contributions, but your contributions and investments become tax-free over time, meaning you won’t incur any taxes through your Roth IRA withdrawals during retirement.
Tax Diversification
Choosing between a traditional IRA and a Roth IRA is an important decision to make, and there are a handful of key aspects that need to be considered. Factors that will likely influence your choice include: income limitations, tax breaks, and withdrawal rules. Investors should have savings in all tax buckets: tax-deferred (traditional IRA), tax-free (Roth IRAs), and taxable (brokerage account) because future tax rates and legislation are uncertain so it is better to be tax-diversified than to have all of your savings in one tax bucket.
What Does it Mean For You?
Who will benefit from a Traditional IRA:
- Someone who does not have a workplace 401k plan offered to them.
- Someone who wants a tax deduction.
- Someone who has all their money in Roth or taxable buckets, but very little in a tax-deferred bucket.
- Someone who cannot do the backdoor Roth IRA because they have a large traditional IRA balance, but would still like tax-deferred growth.
Who will benefit from a Roth IRA:
- Someone who has a workplace 401k plan, does not qualify for a traditional IRA deduction, but still qualifies for a Roth IRA.
- Someone who wants flexibility in short-term withdrawals instead of having to wait until age 59.5.
- Someone who has all of their money in tax-deferred retirement accounts, but very little in tax-free.
- Someone seeking tax-free withdrawals during working years and retirement years.
- Someone who does not want to be subject to RMDs (Required Minimum Distributions).
It’s imperative that these factors are taken into account for anyone in the process of deciding on their retirement plan. Depending on your tax and saving needs, more short-term tax changes may be favorable over long-term deductions, or vice versa. By working with a financial advisor to consider your needs and evaluate your current financial profile, you’ll be able to make a decision that allows you to make a structured plan for the future.
Ara Oghoorian, CFA, CFP®, CPA is the President & Founder of ACap. ACap Advisors & Accountants is a “Fee-Only” wealth management and full-service accounting firm, specializing in helping doctors and healthcare professionals make sound financial decisions.
