Retirement Savings Accounts: Traditional vs. Roth vs. IRA vs. 401 (k)

Believe it or not, it is possible to save for retirement on autopilot. You just have to know where and how.

For most Americans, financial experts recommend automatically contributing to an employer-sponsored 401 (k) program. and an IRA. That's right – it's not a "no more" situation. it's "both, and." Although the taxation of these retirement accounts is objectively good, there are slight variations that are important to consider.

Generally, the 401 (k) s and IRAs are of two types: traditional or Roth. As there are very few situations in which you can completely avoid taxes, the only difference between the two is when your money is taxed. Roth account distributions are tax free, while traditional account distributions are taxed as income. Basically, if you do not pay tax now, you will pay later, and vice versa.

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All of these types of retirement accounts have the option of automatic contributions, whether through salary deferrals or regular bank transfers. Contributing automatically is one of the most powerful tools we have to build retirement funds. When you save each paycheque, you will probably save more regularly, which will increase the chances of your money going up.

This table provides a basic overview of the four types of retirement accounts you will encounter, followed by more detailed information below.

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401 (k) s

A 401 (k) is a type of defined contribution plan in which you transfer a portion of your salary into an investment account. Your employer will also contribute to the account, often in the form of a matching contribution. The money of your 401 (k) is up to you to invest, usually in a selection of mutual funds, index funds and target date funds.

With a traditional 401 (k), you can choose a contribution rate that will be drawn from your before taxes salary. Your savings and your subsequent income will increase completely tax-free. At 59 and a half, you can start withdrawing money from your 401 (k), after which you pay income tax.

Although few companies currently offer a Roth 401 (k) option, it is becoming more and more popular. The Roth layout basically reverses the rules – you contribute after taxes pay in your 401 (k) and be able to withdraw your money tax free at 59 ½ years.

Whether you opt for a traditional Roth 401 (k) or 401 (k) – baduming you have a choice – can be reduced to your marginal tax rate. If you expect to be in a higher tax bracket at your retirement at the present time, you can pay taxes now and pay after tax dollars on your account.

Note that the $ 19,000 limit for 2019, or $ 25,000 for people over 50, is the combined limit for the traditional 401 (k) s and Roth.

IRA

ARIs are a bit more complicated than your 401 (k). They are usually held in brokerage houses, completely separate from your employer. You will have many more investment options in an IRA, which can be a sufficient incentive to open one.

Even if it seems counterintuitive, it is not possible to contribute to a traditional IRA with a pre-tax salary. However, the IRS offers a tax deduction to people who wish to contribute to a traditional IRA, up to the annual cap, which is $ 6,000 in 2019.

You can not claim an IRA contribution deduction (which is used to reduce your taxable income) if you meet the income limits, as well as the rules regarding whether you or your spouse also contribute to a occupational pension plan. .

The Roth IRAs are also funded with after-tax money. Since you can not benefit from tax relief in the year in which you contribute to a Roth IRA, distributions are not taxed as income when you reach age. of 59 years and a half.

The investment options available in the IRAs are the same, whether it is a traditional account or Roth. The choice of use therefore depends on the level of income achieved and the economy of your choice.