Tax Free Roth vs. Tax Deferred IRAs


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Where your money is put has a significant impact on your retirement income. For many retirees, most of their assets are in their IRA or 401(k).

With IRAs and 401(k)s there are two different types that most people have: Traditional and Roth. While you can have both types of accounts, each of these accounts functions very differently.

Having the right type of account can make all the difference in outliving your money in retirement.

IRAs: Tax Free Roth vs. Tax Deferred

Where your money is put has a significant impact on your retirement income. For many retirees, most of their assets are in their IRA or 401(k).

Traditional IRA/401(k) Tax

Most people have a traditional IRA or 401(k). Traditional retirement accounts are funded by tax deductible money. The money you put into the account has not been charged taxes yet.

When you take money out of a Traditional retirement account, the money is taxable.

What this all means is that it is possible you do not have as much money saved for retirement as you think. If all the money you have saved is in Traditional retirement accounts, you need to account for the taxes that will be charged in your retirement income planning.

Roth IRA/401(k) Tax

Roth IRAs and 401(k)s were put into place more recently for those saving for retirement. With these accounts,you put in money after you’ve paid the tax on it.

This means that when you take the money out of your Roth account, it is tax-free, you do not owe any taxes on the money.

Roth 401(k)s can be taxed a little differently if they include employer contributions, so make sure to consult a professional before making any withdrawals.

Listen to learn more about Traditional vs. Roth IRAs/401(k)s:

Why does having a Traditional vs Roth retirement account matter?

Depending on the type of retirement account that you have, distributions can have huge impacts on your income.

If you have a Traditional account, distributions count toward your taxable income. Raising your taxable income in retirement can negatively impact other areas of your finances, such as:

For most people with Traditional accounts, they have the plan of slowly drawing money out over time. Where the real problem lies is when a crisis hits and you need a large amount of this money.

For example, we had a client who came to us with an emergency need for $50,000. While he needed it for himself, many times people come to us needing this money for their children or some other type of emergency.

Since he had a Traditional IRA, we had to actually take significantly more than $50,000 out of his account to pay the taxes. This in turn caused his income to increase by a large enough amount that his Social Security was taxed and he got a letter in the mail a few years down the road that he was going to have to pay IRMAA.

If this client would have had this money in a Roth account, it would have been easy to get this money out and he would have suffered none of the consequences. Roth accounts are a great source of tax free income in retirement.

What can I do to have more tax free money in retirement?

The strategy we recommend to those concerned about having most of their retirement savings in a traditional retirement account is a Roth conversion. With a Roth conversion, you slowly move your money from your Traditional account to a Roth account, paying a lower tax rate along the way.

While this strategy does require really careful planning, and is much easier to put into place if you are younger, at Cardinal, we help retirees do this in a way that makes sense for their budget and preferences.

If you have access to a 401(k) at your workplace, you should check and see if they also offer a Roth 401(k) option. If they do, we recommend, after talking to a professional, switching to that option as soon as you can to get a tax-free pool of money started.

It is always painful to pay taxes on the front end, but for many, the reward is worth it for the ability to have such a huge amount of tax free income in retirement. Cardinal can help you evaluate your situation and figure out the best path forward for you!

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