As published in Star Advertiser on February 6, 2018.
Saving for retirement isn’t easy when it feels like a lifetime away, but those who save early will reap the rewards. Starting at an early age can enable workers to enjoy their golden years full of beach days, golf games and trips to Vegas — in other words, a financially secure retirement.
Most employees rely on their companies’ retirement plan — most commonly a 401(k) — to save for retirement while enjoying tax benefits at the same time. However, there are other tax-advantaged options out there. Individual retirement accounts (IRAs) can play an important role in investing your retirement savings.
Knowing the difference between a traditional IRA and a Roth IRA will help you determine the best way to allocate your contributions.
Both traditional and Roth IRAs give workers the opportunity to save for retirement and receive special tax benefits. They both have penalties for withdrawing earnings before age 59 and a half. As of 2018, traditional and Roth IRAs have an annual contribution limit of $5,500 ($6,500 for taxpayers ages 50 and older).
Traditional IRA (tax-deferred)
Traditional IRAs are tax-deferred, meaning earnings are taxed once they are withdrawn in retirement. Any contributions you make are tax deductible as long as you meet certain income limits, so this can be a great option if you are looking to reduce your taxable income. Once you reach age 70 and a half, you must withdraw required minimum distributions from the IRA on an annual basis, paying income tax on all distributions and earnings, until your funds are exhausted or until death.
Roth IRA (tax-free growth)
Roth IRAs have the advantage of tax-free growth. Contributions are made with after-tax money and are not tax deductible. Because you’ve already paid taxes on these funds, your contributions can grow for years and be withdrawn without paying any income tax, as long as certain requirements are met. A Roth can continue to be funded at any age as long as you have taxable compensation, and there are no requirement on minimum distributions per year. However, Roth IRAs have income level restrictions ($133,000 for those filing single and $196,000 for those filing jointly) so they are not available to everyone.
What’s right for me?
Before you decide on a traditional or Roth IRA, take a look at your employer-sponsored plan. Your first priority when saving for retirement should always be to fund your 401(k) to the point where any employer matching contributions are met — if your employer matches 3 percent of your 401(k) contribution, do your best to ensure you are contributing that 3 percent. Otherwise, you’re leaving free money on the table.
Next, consider your tax situation and savings goals. Younger workers starting out in their career will enjoy the benefits of a Roth IRA because their current tax bracket is lower than what it will likely be in the future. Roth IRAs also protect against an increase in the federal tax rate. Since there is no required minimum distribution once you reach age 70, a Roth IRA is a great way to preserve tax-free assets for your beneficiaries.
On the other hand, a traditional IRA may work better if you’re looking to lower your taxable income. If you’re currently in a high tax bracket and expect your tax rate to decrease after retirement, the tax-deferred structure of a traditional IRA makes sense.
There’s no reason you can’t have both a traditional and Roth IRA— many people do. However, your total contributions to both accounts are still capped at $5,500 annually ($6,500 for ages 50 and older). Check with your financial advisor to see which IRA makes the most financial sense for you.
*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. (“CFS”), a registered broker-dealer (Member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. The credit union has contracted with CFS to make non-deposit investment products and services available to credit union members. CFS does not provide tax advice. For specific tax advice, please consult a qualified tax professional.
David Kimura is the CUSO Financial Services LP (CFS*) investment program manager for Hawaii State Investment Services at Hawaii State Federal Credit Union providing investment, retirement and financial planning services to members. He can be reached at [email protected] or (808) 447-8083.