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Roth vs Traditional IRA and How to Get the Best of Both

Should you invest in a Roth or Traditional IRA…or both?

Most Americans are losing $90,000 because they don’t know the benefits of an IRA or the differences between a Roth vs traditional IRA account.

In this video, I’ll not only show you how to decide between these two types of retirement investments, I’ll reveal a strategy to get the best of both.

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Retirement Accounts are the Best Investments You Can Make

So here’s a question for you. How many hours a week, a month do you spend thinking about your investments? Thinking about how to get a higher return, about how much you need or will have by the time you retire?

If you’re like most people, it’s at least a few hours a month…or a lot more for some of us.

But there’s a good chance you’re missing out on one of the best opportunities to make that extra return, to earn $90,000 or more extra on your portfolio, and all without having to do anything more than you’re already doing.

We’re going to be talking about individual retirement accounts, IRAs and their cousin the Roth IRA in today’s video and this could be the most important video on investing you ever watch.

Average IRA Balance

The Federal Reserve reports that just one-in-three households invests in an IRA. That means nearly 80 million families not taking advantage of this opportunity. Beyond that, Fidelity reports that the people that are investing in an IRA, are only contributing an average of $4,150 a year, well below the maximum and missing out on some big benefits.

So I don’t want to oversell this, I want to get to some IRA basics, the differences between a Roth versus traditional IRA and then a strategy to get the best of both worlds. I do want to share this graphic though, this shows the value of a $500 monthly investment over 30 years in an IRA account versus in a regular taxable account.

benefits of ira investing
Benefits of IRA Investing

Now we’ll get into why these numbers are but look at that, if there was any doubt as to the power of IRA investing, look at that $90,000 difference.

Now let’s get to how you collect that ninety-grand!

What are the Retirement Account Options?

We’ll look at the basics of an IRA and a Roth, the average amount people have invested by age and the big differences between these two investment accounts. I’ll then show you how to decide which to use and a strategy to get the best from each.

So an individual retirement account, an IRA, is a special investing account you set up and you can set these up on almost any online investing platform.

It literally takes no extra time to set these up. When you’re opening an account or opening another on the same site, it’s going to ask if you want it to be an individual taxable account or an IRA so you just click the IRA box and that’s it.

IRA vs Roth Basics

There are two types of IRAs, the traditional which is just referred to as an IRA and a Roth account. We’ll go into more detail on the differences and when to use each but it’s basically when you pay taxes. When you put money in an IRA, you take that amount off your income when filing taxes so that’s an instant tax break.

Even if you’re in the 10% tax bracket, that’s saving you $600 every year from not having to pay taxes on that income. When you take that money out of your IRA in retirement, you pay normal income taxes on everything you take out. So here you’re paying the income tax rate on what you paid in and the returns over the years.

Now compare that with a Roth IRA. With a Roth, you don’t get that instant tax break. You invest in your Roth IRA but don’t take that money off your taxes. Here’s the sweetness though. When you take that money out in retirement, you pay nothing. You already paid taxes on the amount you invested, so there’s nothing to pay there, but you also don’t have to pay taxes on the money you made in the account.

That’s huge and something most people don’t realize about Roth IRA accounts. You never pay taxes on money you made on the investments. Yeah, it’s nice getting that instant tax break with a traditional IRA but you’re still paying taxes on the contributions AND returns eventually.

You get tax-free returns with a Roth. It’s one of the reasons I say every investor needs some money in a Roth account.

There are a few basics here I want you to see then we’ll get to the average people have in their IRA by age, some of those important differences between the Roth and IRA and how to use both.

How Much Can I Invest in an IRA?

You can invest a maximum of $6,000 a year into your IRA accounts and this is total. So if you have multiple IRA accounts, both Roth and traditional IRA, and on multiple websites, you can only contribute $6,000 total into all of them combined. If you’re age 50 or older, the government allows you to invest up to $7,000 a year called a catch-up contribution.

Now that money you invest in an IRA is locked up until age 59 and a half. You control the investments but can’t take the money out without paying a penalty and taxes owed. We’ll talk more about this in a bit but I’m going to show you why it really shouldn’t be a problem.

The deadline for contributing to your IRA is the April after the tax year and this is a big benefit of IRAs. This means you can invest into an IRA by April 2020 to get the tax break for 2019. That’s going to allow you to do some tax planning, figure out whether you want that instant tax break this year or in the future.

I’m all about that company match on 401K plans, that’s free money, but IRAs have some big advantages over a 401K. Since this is your own account you opened and control, you never have to worry about leaving your employer and what to do with your money. IRAs give you more flexibility to invest in stocks, bonds, real estate…basically anything you want versus being trapped into a package of funds in your 401K. IRAs are also less expensive by far compared to all the fees you pay in a 401K.

IRA Balance By Age

Despite all these benefits, only about a third of American households invest in an IRA account. Of those that invest, most aren’t maxing out that $6,000 contribution each year. We see the average IRA balance by age here. So an average around $20,000 for those in their early 30s growing slowly to about $50,000 for those in their early 40s and $92,000 for those in their early 50s.

IRA Balance by Age
IRA Balance by Age

So let’s get the biggest complaint I hear about IRAs out of the way. I know it sucks to have that money locked up ‘til you’re 60 years old…but is it really an issue?

Investors see that they can’t withdraw the money and freak out but you know you need to be saving for retirement, right? What are you going to live off for 30 years of your life? You going to be able to make it on the thirteen-hundred a month from Social Security?

Even while that money’s locked up, you still control it. You can change the investments. You can move the money to a different IRA account on a different website or into a different asset.

There’s really no difference here between your IRA money and the money you have saved in a taxable account for retirement. None…well except for that sweet tax break on the IRA account.

Differences Between Roth vs Traditional IRA

So even though these are both types of IRAs, there are some differences between the Roth and traditional IRA you should know. We’ve already covered the difference in taxes. With a Roth, you pay regular income taxes but get to take all the money out tax-free. With an IRA, whatever you invest is taken off your taxable income that year but then you pay taxes on everything you withdraw in retirement.

You can contribute to a Roth account at any age even in retirement. For an IRA, you can only contribute up to age 70 and a half years old.

There are income limits to contributing into a Roth account, if you make more than $137,000 as an individual or $200,000 filing jointly, you aren’t allowed to contribute but I’m going to reveal a strategy to get around this later. There’s no income limits to contributing into a traditional IRA.

Now if you do take some money out of an IRA early and you don’t meet a few hardship circumstances, you’ll pay taxes on the money plus a 10% penalty. So if you withdraw $2,000 from your IRA before age 59 and a half, that money is added to your taxable income and taxed at your income tax rate and you pay the 10% penalty or $200 on top of your taxes.

Roth accounts are different though. You already paid taxes on the money you put into the account. You can withdraw from your Roth up to the amount you contributed even before you hit that 59 and a half. No taxes, no problem. Now if you withdraw from the earnings you made on investments, you’ll be hit with the tax bill and 10% penalty. So the moral here is don’t touch your IRA money because it’s hugely expensive if you do.

One last difference here, with traditional IRAs you’re required to start taking money out when you hit 70 and a half…and yeah, I don’t know why everything is that half year, it’s completely stupid and takes longer to say…but politicians I guess.

Anyway, money in that IRA, you’re required to take a certain percentage out each year after 70 and pay taxes on it. With a Roth IRA, no requirements. You could be 120 and still contributing or not taking money out of your Roth.

How to Choose Between a Roth vs IRA

Now I want to show you how to choose between the Roth versus traditional IRA and reveal a strategy to take advantage of both but let’s recap the pros and cons here.

With an IRA, you get the instant tax break and that’s great for high income individuals that can save more on current taxes. I feel like IRAs give you more discipline also since you can’t withdraw the contributions like with a Roth. The cons of course are that you eventually pay taxes on everything, what you put in and your earnings, and you have the forced withdrawals at 70.

With a Roth IRA, you’ll never pay taxes on returns. That deferred tax break is great for someone not making much money now so someone that won’t get much from that immediate tax break but the downside is that you’re paying taxes now on the contributions.

But how do you choose between an IRA or a Roth IRA? If you can only invest up to $6,000 a year, how do you decide?

The old school of thinking used to be to use the one with the biggest tax break. So if you’re in a high tax bracket now but maybe don’t expect to have as much income in retirement, you’d take that immediate tax break and contribute into an IRA. On the other hand, if you aren’t making much money now but expect to make more in the future, you contribute into a Roth IRA. You pay your taxes now at the lower rate and then get tax-free income when your tax bracket is higher.

The problem with this thinking is, first, nobody knows what taxes will be like in the future. Not only do you not know how much money you’ll be making but tax rates could be higher or lower so it’s tough deciding between the immediate tax break or taking it in the future.

Second though is that each of these retirement accounts offer some great advantages and you don’t want to limit yourself to just one. Why not get an immediate tax break now AND tax-free income in retirement?

So I’ll get to that strategy on how to get both but I want to cover one last question I get a lot about IRAs and that’s, “Can I have multiple IRA or Roth IRA accounts?”

Uh…yeah, I have five Roth and IRA accounts. I’ve got a Roth and an IRA account on ETrade. I’ve got a Roth on Ally Invest and an IRA on M1 Finance and another account in a privately managed IRA I use to invest in alternative assets.

Not only do I get access to different types of investments on different platforms; for example p2p loans, real estate and traditional stocks. I take advantage of all the little freebies and promotions like getting a $100 cash bonus for opening a new account.

What is the Difference Between Roth vs IRA
What is the Difference Between Roth vs IRA

How to Get the Most Out of a Roth and an IRA

Now to that strategy for getting the most out of Roth and traditional IRA accounts.

First, it’s important to be strategic about what you put into these. You want to focus on cash-paying investments like bonds, dividends and real estate investment trusts when you’re investing in your IRA.

Put these investments in a regular taxable account and you’ll pay taxes every year on the dividends or interest you collect. Hold them in a retirement account though and you’ll get those tax benefits. You won’t pay taxes for decades in an IRA and you’ll never pay taxes on these cash payments into a Roth.

Next is how to split your investment between the two types of IRAs, Roth and Traditional, to get the best of both worlds. So you’re limited to that $6,000 contribution each year. You can put it all in one type of account or split it up.

What I suggest is putting it all into a traditional IRA each year. You get the max on that instant deduction. Then every few years, you do what’s called a Roth conversion. This is where you take some of that money in a traditional IRA and move it into a Roth account.

There’s no limit to how much you transfer. So if you’ve been contributing that six grand a year and you have $18,000 in your IRA, you can move $8,000 into a Roth and keep the rest in the IRA, you can move it all into the Roth or however you want to split it up.

Now you’re going to have to pay income tax on this money you move over since you didn’t pay it when you contributed to your IRA, but you won’t owe any penalties as long as it goes straight from one IRA to a Roth account.

What this does is first it gets over that income limit for high-income families. It’s also going to give you that tax flexibility in retirement though. You’ll be able to withdraw tax-free money from the Roth account and still get the instant tax-savings each year contributing to your IRA. In retirement, you can plan each year to save the most on taxes. In years where your income and tax rate is higher, take a little less out of your IRA and more out of that tax-free Roth. Years where your tax rate is lower, take more from the taxable IRA and let your Roth account grow.

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