The word IRA is often brought up while discussing retirement plans and it’s probably safe to say most people have a general understanding of what it is. But just to be sure, let’s clarify. IRA stands for Individual Retirement Account and it is an investment account that invests in a wide range of financial assets. These include CDs, stocks, bonds, mutual funds, REITs, ETFs, annuities, and others. These assets comprise your investment portfolio, which may also consist of other assets, such as real estate and commodities.
IRA Characteristics
These assets should be negatively correlated according to industry and geography (this means even international stocks!) for full diversification, essentially serving as a hedge against market downturns and inflation. The portfolio should correlate with your overall risk profile, taking into account risk tolerance and capacity, and should be readjusted to more conservative proportions as you age to minimize market exposure leading into retirement.
TRADITIONAL IRA vs Roth IRA
With that being said, let’s explore the kinds of IRAs out there. Each one implies major tax implications, so it’s important to fully understand what’s at stake when choosing. We will begin with the Traditional IRA.
TRADITIONAL IRA
The Traditional IRA is a PRE-TAX retirement account. This means that any funds you put into a Traditional IRA can be deducted from your taxes for that year. For example, if you earn $70,000 a year and put $6,000 into a Traditional IRA, you only owe taxes on $64,000 dollars (barring other exemptions). Putting into this kind of retirement account can drop you down a tax bracket for that year. On the other hand, these funds are growing and the full portion will be taxed upon retirement. For example, if your traditional IRA grows into a respectable $600,000 upon retirement, you will pay whatever tax rate for that year on all that funds. If it’s, let’s say, 24%, you will lose $144,000 to Uncle Sam. But, perhaps you saved lots on taxes by being in a lower tax bracket those years you put into it.
ROTH IRA
The Roth IRA is a relatively new account with its own unique advantages and disadvantages. It works like this: you collect your paycheck, pay taxes on it, and only then contribute funds to the Roth account. Alternatively, you can convert funds from a Traditional IRA by paying taxes and moving the funds into a Roth account. This means that it is a POST-TAX, non-deferred retirement account. After putting these funds into the account, it will grow TAX-FREE. Uncle Sam already got his share, and his hands can never dip into that money again – not even into the earnings. Such a plan gives you a greater knowledge of exactly how much you’ll have in retirement since you won’t have to factor in taxes.
In Conclusion
These are not the only retirement plans available to you, but they are the most basic. We here at Walters Strategic Advisors can advise you on your best course of action and go into greater detail on both kinds of accounts. Feel free to make an appointment at either our Sarasota or Bradenton branches by clicking the button below and we look forward to helping you.
