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Every week I use my years of experience writing about personal finance in my blog called Mr. Money Mustache to answer some of your questions about money and life. Over time, we should be able to cover a nice broad patch of ground, and hopefully spread these useful principles throughout Longmont, just as my blog has managed to reach about 30 million people over its own lifetime.
The idea is that you send in questions to the Longmont Leader at firstname.lastname@example.org and I’ll answer a few of them each week
What is the difference between a regular IRA and a ROTH IRA?
The acronym IRA stands for Independent Retirement Account, and it’s basically a place to stash your money where it will grow slightly faster, because the government blesses these special accounts with some tax advantages.
You can open them through most banks, but I prefer the specialized, low-fee investment companies like Vanguard or Betterment which don’t have salespeople that try to upsell you.
Note: I am going to put some typical numbers in here, with the usual disclaimer that taxes have lots of “gotchas” so you would need to check with a tax pro to get the final details.
Regular IRA: with this traditional account type, you can generally put in up to $6000 per year, and then at tax time you can deduct this amount off of your taxable income, which might cut your tax bill by $1000 to $2000 depending on your tax bracket.
Then, this money grows over time because you invested it in low-fee stock index funds like a responsible person, and you pay no taxes over the years on all of these gains.
Finally, when you are at least 59 ½ years old, you can start drawing out this money without penalty. Because you got a tax deduction when you put the money in, you will pay taxes on the full amount as you take it out. BUT, if you are retired and not earning a salary at this point, you will be in a nice low tax bracket, and thus your withdrawals will barely be taxed.
Summary: Put in money NOW while you are earning a lot and in a high tax bracket, pull it out later when you are protected by a low retirement tax bracket. A nice, legal way to dodge the tax man.
It’s almost the same, except you do not get to take that juicy tax cut in the year you make the contribution. However, the money still grows tax-free in your account. And again, when you are 59 ½ , you can start withdrawing without penalty … and also without tax because you already paid the taxes up front!
The Roth IRA is a good strategy if you’re not in a particularly high tax bracket right now and/or if you expect to be in a higher one once you are retired.
The topic goes deeper than we have space for here: for example, the Roth IRA allows you to withdraw your principal penalty-free even before you reach retirement age, which can be valuable for funding an early retirement. And there are income limits and contribution limits depending on if your employer offers a different retirement plan. Do some searching online and you’ll find these more detailed answers pretty quickly.
This column is intended for informational and educational purposes only and should not be construed as professional financial advice for your individual situation. Please consult with a financial professional before making any serious financial decisions.