Planning for investment is complicated. There is the much vaunted “magic number” that supposedly tells you what you need to contribute to retire comfortably, but with life expectancy on the rise and a future that is unclear, saving can be a burden that young people especially may ignore. What seems to be a growing trend is young people simply not saving, or waiting to save. Reasons could be too many expenses, like student loans, or even general laziness and irresponsibility.
For a growing number of Americans, IRAs are becoming a very real part of retirement savings, and the long coveted 401k is less popular. That merits an examination of how the IRA fits into your retirement strategy and why more and more people are choosing and recommending it.
What is the difference between an IRA and a 401K?
Tax plays a big part. Your 401k is made up of contributions that come before tax is applied. That means that when you withdraw that money later in life, you’ll need to pay taxes on it. Roth IRAs are funded by post-tax contributions. Since you’re paying taxes up front you may actually save money in the long run if your income goes up or down.
The biggest advantage to a 401k is that your employer may contribute to your account, but changes in financial legislation are bestowing some tax benefits to your IRA.
Which is a better, a Roth IRA or Traditional IRA?
Traditional IRAs require taxes paid on withdrawal. That said, according to the folks at Charles Schwab, a Roth IRA can hedge against future risk. Roth IRAs pay taxes now, so in essence they protect you from a risk hike later on in life when you might need the retirement income. A traditional IRA imposes its penalties on withdrawal like a 401k.
Roth IRAs also come with no minimum distribution requirement. That makes Roth IRAs a safe bet for the small business owner who is vulnerable to small market fluctuations.
Roth IRAs are also looked at as safe investments for those looking to transfer wealth between better generations. Your children and their children can earn interest, tax free, and continue to make conitrbutions and grow the money if they so choose.
What about IRA Earnings in the Future? What if I Stop Paying into My IRA?
There are no minimum or monthly requirements on payments, however traditional IRAs may impose fees for those younger than 59 and a half. For most people under 70, an IRA is a safe and tax-free method of saving long term for retirement.
The biggest concern with a Roth IRA is the government. Legislative concerns about fiscal policy makes Roth IRAs somewhat risky. Say another government shutdown occurs, or a fiscal budget crises starts, the government may decide to raise rates and that would affect your investments. The government could also decide to tax your IRA anyway, even if you’ve paid taxes up front.
So if you want to maintain liquidity, build for the future and protect yourself from government (or outside) interferences, you should diversify:
-CDs are good for short term growth
-Mutual funds can grow your money exponentially if you can afford the contributions
-Owning property is a great haven for your money
-What about life insurance to cover your family in the event of an accident?
What about Converting IRAs? Should I Convert my 401k into an IRA?
Many who are self-employed and making less money stand to gain by converting to a Roth from a 401k due to taxation. The lower income bracket means employees get more bang for their buck out of contributions.
What you need to remember about an individual retirement account is that the best contirbutions come regular and are left to grow over time.