Step 4: Savings for Retirement in IRA and Higher Education Expenses
An IRA is an “Individual Retirement Account”. 401(k) and 403(b) accounts are offered by employers; you can’t get one on your own. An IRA, on the other hand, is an account that anyone can pay into, as long as they’re below 70 1/2 years old.
“Why 70 1/2?” you might ask me. I have no idea. Moving on!
Step 4 says “Evaluate the merits of a Roth vs. Traditional IRA in the context of your personal financial situation and max the yearly contributions accordingly”. We now know that an IRA is an Individual Retirement Account, but what the hell do “Roth” and “Traditional” mean?
The difference between a Roth IRA and a Traditional IRA is based around when the money gets taxed. In a Traditional IRA, you are able to add money to the account tax-free now, but it gets taxed when you go to withdraw it in retirement. In a Roth IRA, your income is taxed before it goes into the account, but you’re able to withdraw it tax-free in retirement.
So, if you think about it, adding money “pre-tax”, as it’s called in a Traditional IRA, creates a bigger up-front pool of money in the account. This means that there’s more money sitting around earning interest… with the drawback that it’s taxed when you go to collect it.
Adding money “post-tax” in a Roth IRA means there’s less money earning interest for you, but you get to withdraw it tax-free on the other end.
Currently, I’m contributing to my retirement accounts post-tax. This is where the “personal financial/psychological situation” comes back into play. It’s hard to say what the future holds, and I don’t know if the Traditional, pre-tax method would make me more money in the end. I just love the thought that, when I go to collect my money far in the future, past-me has taken care of everything, and all the money in that account is mine. No tax, no questions, just…