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Traditional IRA vs. Roth IRA

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Another tax season, another reminder that it can be worthwhile to plan investments to try to minimize tax liability. In a Money Talk Video, Marc Amateis explains to Joel Dresang two popular tax-advantaged accounts: Traditional and Roth IRAs. Here is a transcript of the video.

Joel: Marc, it’s tax time, and when it comes to this time of the year, there are certain investment vehicles that have tax privileges with the IRS. Let’s talk a little bit today about individual retirement accounts, or individual retirement arrangements – IRAs.

Marc: Joel, there are two main types of IRAs: the traditional IRA, where you put money away pre-tax. So in other words, the money that you put away is not counted as earned income that year, so you save the taxes on that. It allows the investment to grow tax-deferred for years and years, until you pull the money out in retirement. And at that point in time, as you pull the money out, you’re taxed on it.

The other arrangement is the Roth IRA. It’s kind of the opposite situation, where you put money away post-tax, you pay the taxes on it, then it goes into the individual retirement arrangement. And the tradeoff there is when you pull the money out in retirement, you’re not taxed at all on the earnings that built up over time.

Joel: So, typically, who would benefit more from the traditional IRA versus the Roth IRA?

Marc: Well, they’re both good, obviously. Somebody who’s in a relatively high tax bracket would benefit more from the traditional IRA because, again, they’re saving taxes, and they’re being taxed later on – sometimes maybe 20, 25, 30, 40 years down the line. And at that point in time, they’re taxed at whatever tax bracket they’re in in retirement, which quite often is a lower tax bracket.

In addition, all your money is stilling working for you over that whole time. You didn’t have to put any of the money into the government’s hands, in the form of taxes.

On the Roth arrangement, for somebody, for example, who’s just starting out and is in a relatively low tax bracket, the tax savings isn’t as big for them. They can put the money away post-tax and then never owe a dime of taxes on all of the earnings in the Roth.

Joel: What about making your contributions to the IRA? Is there a certain time of the year that’s optimal?

Marc: Well, it’s best to make it as early in the year as possible because that way it earns and compounds tax-deferred. However, you do get until April 15 of the following year to make your contribution for that year.

Joel: And there are a lot of complicated rules involved with these, and we always advise people to seek professional tax advice. And we’ll also have some links on our website to some of the IRS publications to help folks.

Marc Amateis is vice president of Landaas & Company.

Joel Dresang is vice president – communications at Landaas & Company.

Money Talk Video by Peter May
(initially posted Jan. 24, 2014)

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