best retirement plan

Why Savvy Investors Prefer Roth IRAs

Are you looking for the best retirement plan? People always ask me about what the best retirement account is. There are actually many different types of retirement accounts that you can have access to depending on your employment or business set up. For example employees who work for private employers may be eligible for a 401(k) plan which in general allows up to $18,000.00 of one’s wages in tax advantaged account as of 2017. Government Employees have a similar plan know as a 403(b). SEP- IRAs are available for self-employed individuals and allow contributions of up to the lesser of 25% of net income or $54,000.00 in a tax advantaged account as of 2017. And then of course there are the more common IRAs which in general allow contributions $5,500.00 as of 2017.

best retirement planThese are all nifty tools to get some serious tax breaks. But rather than diving into all the details about what each of those accounts allow, I’d like to take a step back and talk about the difference between Traditional Plans vs. Roth Plans.

What does “Traditional” mean?

A Traditional IRA, 401(k), or other retirement plan typically works like this. You defer taxes on that income now, and pay taxes when you start taking distributions. So let’s say you put in $10,000.00 into your 401(k) this year. And let’s say that money is worth $30,000.00 and you take it back out at retirement. You reduced your taxable income by $10,000.00 in the year it was contributed, but now you have to pay taxes on $30,000.00 when you take it out.

Why is this a good thing? Most passive investors are working class people who expect to live on less when they retire. The period in which they’re at the highest tax bracket is while they’re working. So it can make sense to reduce income in higher tax bracket, and pay taxes later in life in a lower tax bracket. The other bonus is that since you didn’t have to pay taxes on that money, you have overall more money to contribute which result in more money passively growing.

However, there’s a serious draw back to this. If you are a halfway decent investor who’s generating more and more passive income every year, then chances are you will be in an even higher tax bracket then you start taking distributions. So you could wind up losing out in the long run. Especially when you consider how a Roth IRA works…..

Roth Attributes…..

A retirement plan with Roth Attributes generally allows you pay taxes on the money you contribute, but avoid being taxed on the money you take out down the road……..regardless of how much that money grows (hint hint).

Roth Retirement Plans are a marvelous invention for anyone who has a decent amount of time, and the ability to generate superior returns. The reason why is that a savvy investor understands the power of compounding wealth. There is a big difference in the outcome of a portfolio that averages 5% vs. one that averages 10% or higher. And the more time you have, the more that difference is magnified.

It’s not too much of a difference whether you are in the same tax bracket at the time of contributions and distributions. But it makes a huge difference if you are in the highest tax bracket based on your successful career of investing. Paying 10% or 20% on a little money up front can be a huge advantage when you’re taxed at a rate of 30% or higher when you’re ready to start collecting. It can keep tens or even hundreds of thousands in your pocket.

About The Author

herbertkoehler

I am a college drop out who found my passion as an investor. I love the many facets of finance, investing, and business. But even more than that, I love sharing what I learn with others.

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