Hey what's going on everybody? Today I'm going to be covering traditional IRA, Roth IRA,
what the differences are, what the similarities are, and what you should be doing in that regard.
But first, like always, I have to definitely beg for your approval by asking you to hit that like
button, smash that subscribe button, and maybe leave me some love, comments, questions about
whatever you have in the comments section below. So what is the difference between a traditional
IRA and a Roth IRA? Which is better? You know, what, how are they treated tax wise? Are there any
income limits to these things? And uh what should you do? Like which one should you prioritize? Well
we're going to cover all that stuff all right. So I'm going to start off by talking about the
traditional IRA. So the traditional IRA is similar to a 401k you know, in terms of tax treatment
in that whatever money that you contribute to the IRA is tax deductible. That means you know, if you
contribute $3,000 in a year, you get to take that $3,000 to reduce your taxable income, and
then that is your benefit for contributing to that traditional IRA. Now, the cool thing with these is
that they, whatever investments you pick within the IRA, they will grow tax-free which means like
you know, if you pick mutual funds or index funds, if you are earning dividends and interest off of
those funds those dividends and interest income will not be taxed to you, okay. Which is awesome.
That actually, like you know once you get going on a lot of money, that's going to save you a
lot of money in the long run, once you have a lot of funds in the IRA account. So it grows tax-free
and then, so when you withdraw the money, that's when you pay taxes. That's when you get taxed
is on the withdrawal okay. So the withdrawal will be taxed at ordinary income rates. It's
not capital gains, it's ordinary income which are not the favorable rates, but nonetheless you know,
your your funds grew tax-free. You have all this huge amount of money in your account hopefully at
this point, at the point of retirement, and now when you withdraw you just count it as ordinary
income as if you're paying yourself. Now if you're to take the funds out before the retirement age,
which is 59 and a half according to the IRS, if you're to withdraw any money out, you're going to
face a 10% penalty plus income tax. Now I would almost make the argument that you should never
take money out of your retirement account early mainly because of the 10% penalty but because
you don't want to be robbing your future self to you know, fix whatever nonsense you have going on
you know, in your present life. So I don't really recommend taking any 401k or IRA distributions
out before your retirement age. It's going to be costly. There are some exceptions to get you past
the penalties and I'll talk about that later but either way, like I just don't recommend pulling
money from your retirement to cover your ass in the present term. One other fun little, little
attribute about an IRA is that you have to take minimum required distributions when you turn 72.
So you know how I told you when you contribute money that the contributions are tax deductible,
and then it grows tax-free and it's just sitting there tax-free. Well, the IRS will want its money
sometime. It's going to want its tax money. So when you hit the age of 72,
you are required to take some distributions out and the calculation is based on your age and
some other things but you will be required to take some money out and pay taxes on that money because
the IRS wants to get its hands on the on the tax revenue okay. So something to be aware of there.
This also this also applies if you inherited an IRA from somebody, like if your grandfather
passed away, or your father passed away, and you inherited their IRA account,
you will have to start taking required minimum distributions immediately all right. So now
that we talked about the traditional IRA, let's talk about the Roth IRA which is,
I'm sure many of you heard of. Like you know, if you're in the financial world or in personal
finance, you've probably heard people say oh you got to contribute to your Roth IRA,
it's so good you know. Like why is it so good? And that's why I'm here to tell you now. So unlike
the traditional IRA, the Roth IRA acts a little differently. The contributions you make into it
are not deductible okay. So you contribute $3,000 to this Roth IRA, you don't get to reduce your
taxable income by $3,000. However, the funds do grow tax-free just like the traditional IRA, and
here's the kicker, when you withdraw the money out of your Roth it's not taxed. None of it is taxed
as long as you withdraw after your retirement age. Now if you withdraw before your retirement age,
there will, there might be some penalties there and I'll talk about that in a little bit. But the
cool thing is, if you withdraw you know, after you retire zero tax is there. It's incredible right?
So much better than the IRA. Well maybe. I'll go over the differences.
I'll use real life numbers here in a second but just know that you know, it's grown tax-free,
and then it's not taxable when you withdraw it. Now if you were to withdraw some money early,
before your retirement age, you may be subject to penalties just like the traditional IRA okay.
However, it's calculated a little different. So with a Roth IRA, you are subject to penalties
based on the gains that you withdraw. Whereas the traditional IRA, you're subject to penalties on
the entire amount that you withdrew. So here's an example, if you contributed $10,000 to a Roth IRA
and then it grew to $15,000, so it gained $5,000, and let's say you withdrew the entire $15,000
early with no exceptions. Then you will be taxed on the $5,000 gain and you will pay a 10% penalty
on the $5,000 gain. The $10,000 that you contributed will not be taxed, and will not
incur a penalty okay. So that's different from a traditional IRA where if you contributed $10,000
to the plan it grew, it grew to $15,000. If you withdrew the entire $15,000 you're going to be
taxed on the entire $15,000 and you're going to be penalized on the entire $15,000. So
you know, the cool thing about the Roth is that it's got this thing called a basis you know, when
you contribute money to it because it's not tax deductible, you're building a basis, a tax basis
on your contributions. So if you really needed the money from the Roth, you can pull out as much as
your basis and not be taxed or penalized on it. Now same thing applies, I still don't recommend
you withdrawing money from your retirement early because you're robbing your future self all right.
Now there are some things that make an exception to the Roth and traditional IRA penalties where
you can get by without being penalized if you were to you know, meet some of these requirements.
So the first one here is medical, if you needed to pull from your IRA or Roth IRA to make some
you know, medical payments. That may exclude you from any, from the 10% penalty but there are a lot
of limits to this okay, so don't just assume that you can withdraw money to pay for medical and then
you're good. There's actually a lot more limits to this that I'm not going to cover in this video.
There's health insurance premiums, same thing, limits here, if you withdraw your money from your
traditional or Roth you might be able to exclude yourself from the penalties. And then we have
you know, if you become permanently disabled then you can withdraw from these accounts
without facing any penalties. Also you can use the money to pay for higher education costs.
Next we have a you know, house purchase. Every taxpayer has up to a $10,000 allowance in their
lifetime to pull from the IRA or Roth to make a purchase of a house without facing penalties.
You can also draw from this money to pay off IRS debt, or of course if you die then obviously you
won't be penalized, or you're whoever inherits your accounts won't be penalized for withdrawing
on this money. So one thing to keep in mind if you're withdrawing from these accounts,
you probably would still be subject to income tax even if you don't get penalized. So just remember
penalties and income tax are two separate things here. So one thing that people probably talk
a lot about are backdoor Roths. Now why is that a thing? Well because Roth IRAs
actually have income limits and if you make too much money, you can't contribute to a Roth. And
you know, if you make contributions to a Roth in the period where you're not allowed to,
you'll be penalized for that as well, until you pull out the money. So there's this thing
called a backdoor Roth where you take some regular traditional IRA money, you convert it to a Roth,
and you don't make like "contributions" per se, but you're just converting it
and that's called a backdoor Roth. And why is it so popular? Well it's a way for like
rich folks to you know, move their money from a traditional to a Roth IRA. Now when that happens,
you pay taxes you know, on the amount that you're moving over to the Roth. So if you have a $100,000
in a traditional that you want to convert to a Roth, well you're going to pay taxes on the
$100,000 in the year that you converted it. So you know, a lot of talks about you know, how Roth is
so much better or maybe how traditional is so much better, like there's a lot of arguments here but I
just wanted to show you guys actual numbers as to whether or not you should really be so concerned
about whether or not your Roth or traditional should be converted or vice versa okay.
Because it might not matter so much and I'll show you. Here, let's check it out.
All right, here we have a hypothetical traditional IRA okay. Let's say you have a balance of a
$100,000, and let's let's assume that you're going to grow 10% per year in the account,
and you're not going to make any other contributions, you just have this $100,000.
Well here we see over the years this is what your account will look like after five years
if you're growing at 10%. So at the end of year five you're going to have about $161,000 in it
okay. Now let's say we just take all that money out of investments for whatever reason,
and then we just start making withdrawals on it, so it doesn't grow anymore. So here we
have in the first year let's withdraw $50, 000, $50,000, and $50,000 in years one through three,
and then year four we're just going to withdraw the balance. And that's how we get
the same you know, let's say we cleared it out in year four. Well in each of these
years you're going to see that we're paying taxes, we're assuming 25% on the $50,000
in each year. 25% on this $11,000 and that's going to give us this net amount each year after taxes
okay. That's going to equal $120,000ish. Now let's say your friend is like hey man you really got to
convert to a back door, like you really got to do it. And you're like I don't know, I don't know if
it's worth it you know, who knows, let's see. So here, let's pretend that we converted this
$100,000 back at the beginning of this exercise. So we converted it to a $100,000 and like I said,
on the event of conversion you pay taxes on the $100,000. So let's assume the same tax rate 25%.
That means your net conversion balance, or your net, yeah your net conversion is $75,000 okay.
Now let's say we grow it 10% every year, same as before. We get to this amount $120,000.
Now with the Roth remember you withdraw you don't get taxed on it. So since you don't get taxed
money we just take these straight withdrawals without worrying about tax. And it equals $120,000
which as you might notice, is the same net number as the traditional IRA over here okay. So let's
go back to the chair. Let me kind of explain something and talk about this a little bit more.
All right, so what's going on here? I thought the Roth was so much better you know, they would
earn more money, it's tax-free at the end of the, at the end of the time when you withdraw,
like what's going on? Well yeah I mean it's, they're both advantageous accounts you know,
they're better than just putting money into brokerage accounts because you might get taxed
on the dividends and interest as you, as your money grows. So they're, they're tax advantaged.
But essentially they're kind of similar in their growth. They're similar in their net earnings.
The only time you really want to plan, and really be concerned about which account you want to move
over to is when you're worried about tax bracket issues. If you're earning a lot of money you know,
if you are a high earner you want to start planning for you know, do you have a higher
tax rate now in your life, or do you think you'll have a higher tax rate later on in your
life when you retire? You know, that's the kind of planning that you want to do if you're real,
if you want to be really concerned about whether you should put money in a traditional or Roth.
Either way like I don't think you should put so much effort into it and worry because you will end
up in a pretty similar spot either way. So with that being said I'm going to let you, I'm going
to tell you my opinion on the priorities that you should be contributing all right. So first of all,
if you if you work for a job that has a 401k with a match, your employer matches, I would
contribute up to the match. You know, as much as you can where they will match your contributions.
Then your next priority will be the Roth IRA. Obviously you have to be able to qualify to
contribute to the Roth you know, if you make too much money then forget about it,
let's stick to the 401k. But let's just take these priorities and in availability you know,
whatever you qualify for. So first is employer 401k with a match, next priority is the Roth IRA,
and then last priority is a traditional IRA okay. Now if you have a 401k at work
you can still contribute to a traditional IRA but there's income limits there and you might
actually make non-deductible contributions in that case okay. So just be aware of that. I'm not going
to get into that, in the details of that in this video but those are the three orders of priority
that I think people should follow just in general. You know, your situation could be different based
on your income and all that but generally I think that's a good order to follow. And then the most
important thing, the very most important thing is to make consistent contributions and don't ever
let off on that. You know that's probably why the the employer 401k is so attractive because
they just take it out of your paycheck, you don't think about it, it's just gone, and it's yours for
the future. So the most important thing you can do here is regular, consistent contributions,
don't touch it, don't withdraw early, just be sure to get those contributions in,
and get them invested in something good okay. Time in the market is better than timing the markets
all right. So that's all I've got for today. Thanks for listening. If you have any questions,
hit me up in the comments below. Again if you would, I would love it if you would subscribe
to my channel, smash like button, all that crap. And take care for now. I'll see you next time.