TRADITIONAL IRA? ROTH IRA? WHAT ARE THOSE THINGS?

We no longer believe in the “Work hard for your company for 30-40 years with a good pension, THEN RETIRE” Our grandparents/parents may have done it, and it worked well FOR THEM! With the way inflation is going and the cost of living is skyrocketing, we will be carrying our own selves to the graveyard to save some money.

Now that I got that out the way, IRA- stands for Individual Retirement Account. Yes, RETIREMENT! Impatiently waiting for that day.

You know how we previously talked about High Yield Savings Accounts (HYSA)? Yes, you know because you read it and already opened at least your first HYSA.

You’re asking what those have to do with these three letters- IRA you’re talking about? WELL, IT IS COMPOUND INTEREST, which is key to growing money and let your money work for you! Oh, and PATIENCE!

A quick example:

Initial Investment (March 2023): $1,625.00

Monthly Contribution: $541.66

Length of Time (Years): 30 years

Average Annual Return Rate (if invested in ETFs/Mutual Funds):10%

In 30 years, you’ll have $1,096,250.47

Let’s say you do apply the same strategy but using your traditional bank’ savings with an average annual interest rate of 0.08%, you’ll have $198, 700.63 in 30 years.

Let’s say you do apply the same strategy but using your HYSAs with an annual interest rate of 3.75%, you’ll have $364, 189.14 in 30 years.

Numbers don’t lie! Now let’s get back to IRAs

The difference between Roth IRA vs. Traditional IRA?

Roth IRA is an investment account that allows you to invest money for retirement, BUT the money you invest is after taxes. The good part about this, is that you never have to worry about paying taxes on it again- meaning, your profits on that account will be TAX-FREE! Trust me, that’s the goal! You must also make under a certain amount yearly to be eligible for a Roth IRA. We’ll go over numbers later.

Traditional IRA is an investment account that lets you invest money for retirement, BUT the money you invest is taxed LATER when you’re ready to withdraw your money. You do get to claim the money you invest yearly when you file your taxes. So, since you do get a “tax break” now, you will have to pay taxes on the amount you invest and the profits you earn over the years. You can open a Traditional IRA no matter how much you make, no matter what your tax bracket is. For those on the higher income spectrum, you can use the backdoor Roth IRA strategy to take benefits of Roth IRA’s benefits. We’re not going to cover this day, it’s a bit complicated but if that is you, let’s talk here!

If people think they will earn less at retirement, they tend to go the traditional IRA route because they pay less taxes (keep in mind you pay taxes on your profits too).

Read the Roth IRA income limits in 2023 Your Tax Filing Status, your 2023 Income(changes yearly), and your 2023 Contribution (Changes yearly.

Read the Traditional IRA tax deduction limits in 2023 Your Tax Filing Status, your 2023 Income (changes yearly), and your 2023 Deduction). Remember the Traditional IRA does not have an income limit.

Where should you open an IRA, you may ask?

Honestly, it is based on your preference, it’s like opening a HYSA or a bank account. Check with your bank, most of them usually offer IRAs or you can choose a brokerage firm like Fidelity, Vanguard... again, it’s up to you, and do your own research. Pay attention to fees as well! I personally have Fidelity and Vanguard, and I love them equally. I like to spread my eggs across different baskets. See what happened with Silicon Valley Bank (SVB). Once you open your investment account (IRA), you must link it to your bank account so you can fund it.

Now that we have the basics about IRAs out the way…Don’t just fund the Investment Account (IRA), you must “buy” investments so it can actually make you money.

What investments should you buy in your IRA?

Again, it’s a matter of what your goals are and how old you are (whether you can afford to be super risky or not). If you’re on the younger side and do not plan to retire anytime soon, then you may be able to afford to have your account be mostly Stocks. I personally invest in Mutual funds and ETFs instead of individual stocks. However, if you plan to retire pretty soon, then you’ll want to be a bit less risky, and invest in more secure investments like bonds.

A mutual fund- an investment that pools together a large amount of money from investors to purchase a basket of securities like stocks or bonds

Exchange traded funds (ETFs)- invest in a basket of securities, such as stocks, bonds, and commodities, just like mutual funds. Unlike mutual funds, ETFs can be traded whenever the markets are open, just like individual stocks.

Bonds- A bond is simply an IOU (phonetic acronym of the words "I owe you," is a document that acknowledges the existence of a debt) that a borrower must pay back over time. The same way you might take out a mortgage to buy a home, a company may take out a loan to finance a new project, or a government may issue bonds to finance infrastructure spending.

So, let’s summarize all this:

• Your brokerage firm is your bank

• Your IRA is the type of account you open at your bank

• Just like anything, you must follow rules that the account has, and that changes every year (Income and Contribution/Deduction)

• For Roth IRA, you can withdraw the money and profits anytime you want with no further tax liabilities or penalties (YOU ALREADY PAID INCOME TAX AT THE TIME OF CONTRIBUTION)

• For your Traditional IRA, you can withdraw the money you invested and your profits after the of age 59.5 with no penalty and your account has been active for at least 5 years (MUST PAY THE TAXES ON MONEY INVESTED AND PROFITS)

• You can withdraw the money you invested and your profits with a 10% penalty before the age of 59.5 and when your account has not been active for at least 5 years. (MUST PAY THE TAXES ON MONEY INVESTED AND PROFITS)

• Bonds, Stocks, ETFs, and Mutual Funds are what are held within your IRA

• Every year, there is an Annual Rate of Return on your IRA, which is not a set number like a loan because the market is unpredictable

• Historically ETFs and Mutual Funds have had an average Annual Rate of Return of 8%-10%. Your bank’s Annual Interest Rate is about 0.08% on a good year! Shrug!

So, go ahead and open an IRA, set recurring transfer every month or every other week, automate your investments, AND FORGET ABOUT IT NO MATTER WHAT THE MARKET IS DOING! I do everything I write about, below is my account with Fidelity!

If you are a parent, godparent, or grandparent, we’ll talk about how to set your little ones up for financial success next using the same strategy!

If you want to pick my brain and would like my help, let’s link here!

The blog articles on this website are provided for general educational and informational purposes only, and no content included is intended to be used as financial or legal advice.