Traditional and ROTH Contribution

Traditional and ROTH Contribution

Overview

In today’s world, many investors recognize the powerful method of deferral taxable gains under a tax sheltered environment such as a 401(k) plan or Individual Retirement Account (IRA). Both methods serve as a key component for the average Americans in terms of building wealth. Such wealth creation is based on the underlying investments, deferral amount, and taxable nature at retirement. For simplicity, Traditional and ROTH means taxable and non-taxable at retirement, respectively. Such arrangements are available in core retirement products.

 

The current maximum deferral for the 401(k) and IRA are:

  • 401(k) Plan: $18,000 elective deferral with opportunity for $6,000 in additional catch-up contribution (Age 50+)
    • Note: It is up to the employer to allow for ROTH contributions in the plan
  • IRA: $5,500 elective deferral and $6,500 elective deferral for employees age 50+
    • Note: Traditional and ROTH IRA are subject to certain restrictions based on house hold income
  • Of course, there are other retirement products in the marketplace, but for today’s post, let’s focus on the core products that touch the majority of Americans.

 

For the sake of illustration, the following sections summarize an overview of Traditional and ROTH and followed by final thoughts.  Our scenario assumes the Person’s (or example) income qualifies for the IRA.

 

Traditional 

  • Lowers taxable income in the given year
  • Investment grows tax deferred
  • Distribution is taxable at retirement
  • Must start withdrawal at age 70 ½
  • Deferrals cannot be taken out prior to age 59 ½. Unless:
    • 401(k) Plans: Generally speaking, employer sponsored plans allow for loans subject to hardship requirements
    • IRA: May allow for first time home buyer exemption to withdraw $10,000 for down payment

 

ROTH

  • Does not lower taxable income in the given year
  • Investment grows tax deferred
  • Distribution is NOT taxable at retirement
  • Deferrals cannot be taken out prior to age 59 ½. Unless:
    • 401(k) Plans: Similar to above, employer sponsored plans generally allow for loans.
    • IRA
      • May allow for first time home buyer exemption to withdraw $10,000 for down payment
      • The principal dollar amount can be taken out anytime

 

Final Thoughts

A mix bag; in other words, we need someone with a crystal ball to predict the future tax structure. For example, in my portfolio, I maintain both ROTH and Traditional mixture. This way, depending on future tax brackets, it provides greater flexibility. If tax brackets are higher at retirement, I may venture to withdraw from the ROTH portion. On the other hand, if tax brackets are lower in retirement, I will withdraw from the Traditional account. Ultimately, it depends on your cash flow income in retirement, but with options, it creates flexibility in your retirement years.

 

What are your thoughts?

 

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