The difference between an IRA and a ROTH IRA can be confusing for some. In this chapter I will explain the key differences between the two retirement accounts and their key advantages. “Do I need to have both accounts?” I would recommend having both but again this depends on your circumstances. An IRA and a 401(k) are pretty much interchangeable, so if you have a 401(k) I’d recommend having that and a Roth IRA. In simple terms for an IRA/401(k) you are deferring taxes which means you will pay them later when you do decide to retire. As opposed to a ROTH IRA which is money that has already been taxed and taxes have been paid. In a ROTH any growth or profits in the account are not taxed when you decide to pull out at or after age 59½.

Why an IRA

The reason you would open up an IRA (Individual Retirement Account) is if you are self employed and don’t have a work sponsored 401(k). You can contribute money into this account, then deduct that money from your yearly taxes. This gives people who are self employed the same tax deferred advantage as someone with an employer making 401(k) contributions to an account. Another good reason for opening up an IRA is to consolidate your old employer 401(k)s. Like I said before these accounts are pretty much interchangeable so if you have previous employers who you don’t work for anymore you can take your old plans and do what’s called a “roll over IRA” when you roll over your money from a 401(k) it keeps the same tax deferred advantage until you decide to pull it out starting at age 59½. A great advantage to this is you can decide where your money goes and keep it all in one account. This prevents you from paying multiple people across different accounts to manage your money. Sadly it costs money to have money. The lower you pay on fees the better. It gives you more money for you to grow for your future.

More benefits to playing with pre-tax dollars are that there are more of them. Since technically you not paying taxes on the money yet, more money goes into the pot and the more there is invest and grow. The downside is that you don’t know if taxes are going to go up in the future. You’re just deferring the taxes so they will have to be paid eventually.

Why ROTH

I could go on forever on why everyone should have a ROTH IRA account. The main key advantage to this account are the money contributed to this account has already been taxed so all profits are tax free. The catch is, if you want to withdraw any profits (money gained) it must be done after age 59½. You can withdraw your principle at any time without penalty, the catch is this doesn’t reset your yearly contribution limit. So for example if you deposit $6,500 and profit some money, you can withdraw ONLY your $6,500 principle without penalty. Any additional withdrawals that aren’t your original principal will get penalized for taxes. Also you cannot redeposit that money once you withdraw.

You cannot roll over a 401(k) to a ROTH IRA. The rules on the money are different pre-tax as opposed to after-tax. Unless you specifically started contributing to a workplace ROTH 401(k). If you contribute to a ROTH account type for your workplace look into the yearly limits of contributions because 401(k)/401(k) ROTH deferral maximums are different from IRA/ROTH IRA maximums. You don’t want to go over the yearly limit.

A problem for the ROTH IRA account is that you have to have a source of income to be able to contribute and make less than $153,000 (in 2023, single filer. Income cap goes up every year). Also after tax dollars are less than pre-tax dollars. So you’re technically playing with less money, which means slower growth. But at least the growth is guaranteed. You don’t have to guess how much your net worth is by calculating taxes. What you see in a ROTH account is all yours.

Why Both?

Contributions to both accounts will be completely beneficial and ensure you have more chances of success during retirement. You can even strategize how you use your money from both accounts. All money from the ROTH IRA won’t count as income for example unlike a traditional IRA or 401(k). You can pull out an distribution of 50k from your traditional IRA and another 50k from your Roth. Since you already paid taxes on the Roth you’ll only pay taxes on your Traditional IRA “income”. All while living big when you retire.

Final thoughts?

Does this change how you see retirement accounts? Now that you know the benefits to having both types (pre and after) tax accounts. How will this change how you contribute to your future?

Thanks again for reading and see you next Sunday,
– Pablo