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A Traditional IRA Or A Roth IRA: Which Is Best?

Which is best – a Traditional IRA or a Roth IRA?

That's a great question, and there's no cookie cutter answer which is applicable to everyone. Each person's financial situation is different, and different needs call for different solutions.

And while you don't necessarily have to choose one over the other (you can invest in both a Traditional IRA and a Roth IRA), keep in mind that your annual IRA contribution limit applies to both retirement accounts, so a contribution to one means less money you can potentially contribute to the other.

For example, if your annual IRA contribution limit is $5,000, you can NOT contribute $5,000 to your Traditional IRA and $5,000 to your Roth IRA. If you contribute $5,000 to one, you can't contribute any amount to the other. And if you contribute $3,000 to one, the most you can contribute to the other is $2,000. So you have a big decision to make when it comes to allocation of your retirement savings.

Below are just a few of the factors you need to take into account when trying to decide whether you should invest your hard earned money in your Traditional IRA, your Roth IRA, or some combination of both.

Roth IRA Vs Traditional IRA

Tax Deductibility

One of the primary factors to consider when evaluating the benefits of your Traditional IRA vs. your Roth IRA is tax deductibility.

Generally speaking, contributions to your Traditional IRA are tax deductible – meaing you make your contribution with pre-tax dollars, which lowers your taxable income, and then you pay your taxes. On the other hand, contributions to your Roth IRA are non-deductible – meaning you pay taxes on your gross income first, and then make your contribution with after-tax dollars.

Which is best? It really depends on a number of factors unique to your own financial situation, but as a general rule, if you're in a high tax bracket now and you anticipate being in a lower tax bracket when you retire, you might want to take advantage of the tax deductibility of your Traditional IRA. But if your tax bracket is lower now than you expect it to be in retirement (or you think it will stay the same), then you might want to take advantage of the tax-free withdrawals offered by your Roth IRA.

Taxes Upon Withdrawal

Another factor to consider is how your money is taxed when you finally make withdrawals during retirement.

With your Traditional IRA, you owe income taxes on any funds you withdraw during retirement (since you originally made tax deductible contributions), but under the Roth IRA rules, all qualified withdrawals are tax-free when you retire (since you originally made non-deductible contributions).

Which is best? Obviously, we all prefer tax-free withdrawals from our retirement savings, but again, you can't look at these two factors in isolation. You need to weigh each option relative to the type of contributions you make (deductible vs. non-deductible). In most cases, it's a wash. You either pay the taxes upfront (non-deductible Roth IRA contributions) or you pay them later (taxable Traditional IRA withdrawals).

However, keep in mind that if you're capable maxing out both accounts, you end up with more money in retirement if you choose your Roth IRA. Why? Because you're able to contribute more.

For instance, let's say you contribute $5,000 to your Roth IRA and your spouse contributes $5,000 to a Traditional IRA. You invest both accounts in identicle assets so that when you reach age 60 both accounts are worth $200,000. If you're in the 15% tax bracket, your Roth IRA is still worth $200,000, but your spouse's Traditional IRA is only worth $170,000 because any withdrawals are subject to income tax.

Required Distributions

One last factor you need to consider is required distributions.

By law, you must begin taking annual distributions from your Traditional IRA at age 70 ½ whether or not you want to. But with your Roth IRA, you don't have to worry about required distributions. If you so choose, you can continue investing in your Roth IRA until the day you die, regardless of how long you live.

In this respect, your Roth IRA is a superior option because it gives you more flexibility. You choose whether or not to withdraw funds from your retirement savings, and no arbitrary rules dictate a forced withdrawal. This gives you greater freedom to plan your finances during your retirement years. After all, not every 71 year old needs to withdraw funds from a retirement account. Many are still working, and among those who are retired, many can live comfortably off of social security benefits, pension income, and other investments. So why paint yourself into a corner?

Which Is Best?

Aside from the required distribution provision which forces you to withdraw funds from your Traditional IRA, you can't make a blanket statement applicable to everyone regarding which is the better option – a Traditional IRA or a Roth IRA.

Only you can decide which one is your best option, and you do so by examining your individual financial situation, assessing your current and projected tax brackets, using a Traditional IRA vs. Roth IRA calculator, and/or taking into account any additional forms of income you may have in retirement.

In the end, you may find one is a clear winner over the other, or you may decide to hedge your bets and split your annual IRA contribution between the two accounts.

This is a guest post from Britt at http://www.your-roth-ira.com, the Web’s #1 resource for Roth IRA information.

Could An Annuity Be The Ticket To Reliable Retirement Income?

By Miranda Marquit 2 Comments

With the 2008 financial crisis still fresh in some minds, one of the questions many are asking is this: Is there a way for me to protect my nest egg from market drops during retirement? One of the financial tools receiving a second look right now is the annuity. However, annuities have something of a bad name right now because so many of them are complex and costly.

But that doesn't mean that all annuities are bad, or that no one should ever get one. There are some annuities worth considering, and some retirees, with the right annuity, can do well incorporating one into the retirement strategy.

Indexed Annuity

One of the types of annuities gaining in popularity is the fixed indexed annuity. This is an annuity that promises a fixed rate of return (usually pretty low), but that also leaves the door open for greater returns because the annuity follows an index. So, you are protected from loss because there is a minimal rate of return, but at the same time there is room for you to see better returns because the annuity's performance is connected to how a specific index performs.

You can choose to invest in the annuity before retirement, and build up to a payout later, or you can choose to get an immediate annuity. With an immediate annuity, you take part or all of the money in your retirement account and use it to purchase an annuity which begins offering regular payouts immediately. You have a fixed income stream now, and it can be used to fund you during retirement.

Things to Consider Before Getting an Annuity

Of course, an annuity isn't for everyone. Before you agree to an annuity, you should consult with a knowledgeable and trusted financial professional. (Be wary of those pushing a specific annuity product, and receiving a commission for it.) You should consider the risks associated with annuities, as well as some of the complicated surrender policies and inheritance policies that come with some annuities. Here are a few things to keep in mind as you consider annuities:

Stability of the company: Annuities are offered by insurance companies. If the insurance company goes down, you risk losing your money. A minimum guaranteed rate of return is no good if the insurance company goes down. There are some state funds that offer insurance against this sort of loss, but you do need to be careful. Check ratings and determine the strength and stability of the company.
Costs: All annuities come with fees. However, some annuities have higher fees than others. Find out about total yearly costs, as well as costs associated with mortality and other issues. You might need to pay additional fees for extra features.
Inflation adjustment: Find out if the minimum guaranteed return will be adjusted for inflation. A 2% guaranteed annual return still results in a loss of spending power if inflation is at 3% or 4%. Look for annuities that offer inflation adjustments.
Surrender period: Make sure you are clear on this, and the terms of how you can withdraw money from your annuity. Otherwise, you might find yourself racking up extra fees.

Like many financial products, annuities aren't all bad. They are worth considering, and, when used properly, they can provide you with a way to ensure retirement income.

Double Check Your Employer’s Retirement Plan

By Miranda Marquit 3 Comments

When you work for an employer, you might have access to benefits, including a retirement plan. Your company's retirement plan — usually a 401(k) — can be a way to help you build your nest egg through the power of investing and compound interest. However, you want to double check to make sure that your employer's retirement plan is what you want to be devoting your resources to.

In some cases, you might not want to rely too heavily on your employer's retirement plan to build your wealth. Here are some things to consider:

retirement plan double check

Matching Contributions

One of the biggest advantages of many employer sponsored retirement plans is the matching contributions that you can receive. Your employer will match your contribution up to a certain amount. This is free money that goes into your retirement account.

Before you sign up, make sure that you check into the vesting rules. In some cases, the employer portion of your contribution might not be available to you for a certain number of years. If you're planning on changing jobs in the next couple of years, you might lose the employer match portion because of vesting rules.

Employer Stock

Another consideration is how much of the plan's investments are in company stock. Some retirement plans require that a large portion of your contributions buy employer stock. If the company goes down, this means that you lose out in your 401(k), as well as in terms of your job. An employer's plan that is heavily weighted in its own stock might not be the choice for a large portion of your money.

Investment Options and Fees

What investment options are available with your employer's plan. Some plans only provide options to invest in managed funds with high fees. Other plans may not provide you with enough options that you are interested in. You want to be able to make decisions that work best for you, and if your company plan is light on low-fee options, you could lose a lot of money on unnecessary costs.

What to Do if You Aren't Happy with Your Retirement Plan Options

You can always talk to your human resources representative about your options. You might be able to persuade your employer to re-vamp the plan offerings. If this isn't possible, consider your other options. If your employer offers a matching contribution, it might be worth it to contribute the maximum you can to get the match, and then use an IRA for the rest. You can open an IRA even if you have a 401(k) at your job. This can make it possible for you to invest in low-fee options with the bulk of your contributions.

In some cases, employees will fully fund an IRA, and then invest whatever's left in terms of budgeted contributions with an employer's plan. It's important to weigh your options. A tax-advantaged account has benefits that a “regular” investment account doesn't have when it comes to the long-term. Consider what is likely to work best for you, and how you can make the best of the situation if you aren't happy with your employer's 401(k) options.

Why NOW Is The Best Time To Start Saving For Retirement

By Miranda Marquit 4 Comments

Actually, years ago was the best time to start saving for retirement. As soon as you started earning income was the best time to save for retirement. But now is the second best time to start saving for retirement.

Don't wait until you have “enough” money to start a retirement account. Many brokerages offer you the ability to start saving for retirement with a rather low account minimum. You can pretty much start saving for retirement with any amount of money.

Start Saving Now

Get In The Habit

One of the best reasons to start saving for retirement now ist that you get in the habit. Even if you can only contribute a few dollars a week to a retirement plan, the fact of the matter is that you are developing the habit of setting aside that money.

Besides, you might be surprised at how much money you can “find” to set aside for retirement if you look around a bit. You can increase your income through creative means, or you can reclaim wasted money by cutting back on expenses. In either case, the result is to look for money that can be put toward the future.

However, you don't want to remain complacent about the amount of money you contribute to your retirement account. As your income increases, so, too, does the amount you should be able to put into your account. Periodically evaluate your retirement account contributions and make changes to the amount. But the idea is to start as early as you can, so that you develop the habit of setting money aside for retirement. The practice of thinking ahead with your money is a vital one to be in if you want to create a successful financial plan and achieve financial freedom.

Dollar Cost Averaging

When you start now, and put a regular amount aside as a retirement contribution, you are taking advantage of dollar cost averaging. This is a great way to affordable build up your retirement account, while getting the habit of saving. The idea behind dollar cost averaging is that you use the same amount of money each month to buy however many shares of an investment that you can.

In times when the market is down, your retirement contribution dollar goes further, purchasing more shares for less. (Of course, when the market is higher, you get fewer shares for your money.) This means that it actually isn't a bad idea to build your portfolio during times when the market is struggling. You'll be able to buy more shares, and later, as the market moves higher, those extra shares will be worth even more.

Put Compound Interest To Work For You

Another reason to start now is that you have more time for compound interest to work on your behalf. The sooner you start investing, the more time the interest you are paid has time to earn interest of its own. There are numerous studies and articles written about how starting just five or 10 years earlier can make a huge difference in the amount of money you ultimately end up with. Get started now, and your money will have more time to work on your behalf, resulting in a larger nest egg by the end.

Retirement: Know Your Housing Options

By Miranda Marquit 1 Comment

As you prepare for retirement, one of your challenges is going to be figuring out where to live. The process of aging means that you might need special care as you get older. Where you live can affect the sort of care you get, as well as your ability to access services that you need — especially in terms of health care.

What Are Your Preferences?

Before you end up in a position where you are forced into a decision, it's a good idea to determine your preferences ahead of time. Some people expect that, once their children grow up and move out, they will downsize to a smaller home. Others expect to remain in their house forever, particularly if they have bought the home and expect it to be a retirement asset. In some cases, a fixed domicile is unattractive, if the goal is to travel. My grandfather has a small trailer in a park in southern Arizona. It's a park populated by retirees escaping the winter. During the summer, he pulls out the truck, hitches up his camp trailer, and travels all over, visiting family, and going on hunting, fishing and camping trips.

Housing in retirement

Your first task is to figure out what living arrangement will work best for you. After you know that, you can begin to make plans for the future.

Considering Costs

Initially, your retirement housing is unlikely to cost very much. Chances are that you will be reasonably healthy, and have no special requirements. However, you will eventually need a transition plan for your living arrangements. You might decide to move into a retirement community, an assisted living facility, or even a nursing home. The bigger your health needs, the costlier your living arrangements will be. A properly structured long term care policy can help you prepare for the costs associated with assisted living, or with a nursing facility.

It is worth noting, too, that you can receive care at home. There are home care options available, in which health care specialists come to you, in order to ensure that you have the help you need. However, if you don't want to eventually rely on family members to care for you at home, you might have to eventually make arrangements for living in a more permanent facility.

Another possible cost has to do with a reverse mortgage. Some people choose these financial products in an effort to get a little more cash flow each month. If you die in your home, it usually works out fine for you — although your heirs will have to deal with selling your home to pay off the mortgage. If you end up moving, though, even if your health fails and you move to a nursing facility, your loan becomes due. Being stuck trying to pay off a reverse mortgage is the last thing you want to deal with as you are trying to transition to a new retirement living arrangement.

Bottom Line

Now is the time to consider your situation, and your preferences. Think about where you might want to live, and how much it is likely to cost. Then, create a plan that allows you to maximize your retirement so that you spend more living where you want.

Reduce Your Debt And Save For Retirement

By Contributor 4 Comments

As an investor, you are constantly trying to stay on top of your personal finances. Two of the biggest and most daunting goals you may face are paying off your debt and saving for retirement.

For young investors, retirement may seem to be a vague and far away goal, causing some to lower or stop retirement plan contributions altogether in order to have enough money to reduce their current debt. You may be asking yourself, “How can I possibly pay down my debt while saving for retirement?”

debt and retirement

Of course, there is no one-size-fits-all answer regarding how to balance your debt repayment strategy with your retirement savings strategy. Everyone’s situation is different, but here are a few guidelines that can help with your financial questions:

If your company offers a 401(k) plan with a matching contribution, then continue your retirement plan contributions as long as it’s financially possible. An employer match provides a return that is hard to beat, so avoid stopping your contributions to pay down your debt. Passing up your company match is basically saying no to free money. The benefits of compounding and dollar cost averaging both depend on long-term investing.

Make sure you take time to evaluate your spending habits and tighten your budget accordingly. By structuring your budget, you can make sure you are contributing enough to take advantage of your company match while at least paying the minimum amount on all your debts to avoid late fees. If you have to reduce some monthly bills, such as internet or cable to have enough to pay off your debt, then find a way to do that before jeopardizing your financial future. Although having the best cable and internet package may provide you great entertainment, it’s important to value your long-term goals more than your immediate gratification. However, if you must reduce your 401(k) contributions to have enough cash flow to reduce your debt, decrease them by as little as possible.

Most importantly – try to prevent additional debt in the future. Think twice before purchasing something that is not a necessity and review the financial consequence it may have on your expenses. Also, consider creating an emergency fund. The thought of putting aside more money may be unpleasant, but an emergency fund will help you from falling into debt again. You never know what the future might bring, so it’s always better to be financially prepared for the unknown.

Use a 401(k) contribution calculator if you are concerned about your take-home pay after contributions. You may be surprised to find that your plan contribution does not affect your take-home pay as much as you would think. Remind yourself that you are making pre-tax contributions and the amount of taxes withheld will be reduced.

The best solution for someone struggling with debt and trying to save for retirement is finding a happy medium between the two. Although decreasing your take-home pay may not be an ideal situation while paying off your debt, you will regret not at least taking advantage of your company match. Your employer match is an immediate return on your investment. Start contributing today, if you haven’t already.

Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.

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