Retirement Planning and Preparation

Attaining financial security in your later years is something that all Americans desire, but few prepare for. Our daily lives can be hectic with our work and short-term needs, making planning for something like retirement seem distant and out of reach. To some, the planning aspect can be daunting, juggling the pressures of our current expenses with the idea of adding an investment account that we likely won’t touch until years down the road.

Nevertheless, not planning and saving for retirement can pose a massive financial opportunity cost that’s worth your attention. At a minimum, formulating a retirement plan forces you to analyze your current finances, project your financial future, and calculate potential outcomes. You may be very surprised once you run the simple exercise of calculating the small consistent contributions coupled with the benefits of potential tax-advantaged investments over time.

Imagine that you’re 25 years old and start a traditional IRA with the goal of retiring at 65 years old. We will assume that you contribute $5,000 annually to your IRA and have a return on your investments that equates to the average approximate returns of the S&P 500, which is 7% per year. Assuming those numbers hold true, your money will balloon to over $1 million by the time retirement rolls around and over $900,000 after withdrawing the money and paying deferred taxes*. While no one can predict the future and performance will vary, it is fair to say that IRAs become much more intriguing if you assume a moderate return on your investments over the long term.

**Tax Implications for Traditional and Roth IRAs

As you can see whether you are 25 years old or 45 years old, planning for your retirement is something worth investigating, sooner rather than later. By taking the initiative to open either a Traditional or Roth IRA, you will put yourself in a position to save precious dollars on your retirement investments. Consequently, you’ll want to know the tax structure of each so that you can optimize your hard-earned contributions over time.

The key difference to consider lies in when you are taxed. With a Roth IRA, contributions are derived from after-tax dollars, meaning you are taxed upfront. Your investments mature tax free until you’re 59 1/2 years old.

Traditional IRAs are structured in such a way that you contribute pre-tax dollars, meaning you pay no taxes on your initial investments but are taxed when you withdraw your funds. Tax-deductibility depends on your income, however. If your income is above a certain threshold, there are limitations.

**Which is best for me?

A fundamental factor to contemplate is whether you think you will be in a higher or lower income tax bracket than you are now at retirement. While most investors cannot be sure of their future income, you want to do your best to predict. If you anticipate having a higher income by the time you withdraw money, a Roth IRA may be more optimal. Those who see themselves being in a similar or lower tax bracket at withdrawal time, are likely better off selecting a Traditional IRA. One exception to the above paragraph is that high-income individuals face limitations on contributions in a Roth IRA. If your income is above the highest threshold, you may not be eligible to contribute to a Roth IRA at all and thus would defer to opening a Traditional IRA.

Taking Control of your Investments

Regardless of which structure you choose, IRAs are self-directed investment vehicles. Unlike other retirement accounts like 401ks, you are not hand-cuffed to choosing between only a few investment options often run by outside institutions. With IRAs, you gain the freedom to make your own investment decisions, in the way that best fits you.