Traditional Vs Roth Accounts: Which Is Right For You?

We care as much about you and your lifestyle as we do about your plan . At the Bowman Wealth Group , we want to help you define what matters most and inspire you to go and do it . Your host is Bowman Wealth Group financial advisor Scott Vellon , who , for more than a decade , has provided financial leadership for those he serves .

Each episode we tackle a different topic and do a little deep dive into it . Some of it might be basic and some of it might be really in-depth . Everyone has a different understanding of financial concepts so I try to keep it easy to understand , easy to grasp for the folks that aren't super in-depth or under in their knowledge of finances .

This episode is going to be about traditional iras and Roth iras traditional 401ks and Roth 401ks what are they ? What are the differences ? What are the pros and cons ? What does it all mean ? As I always say , if anything you hear prompts more questions or you want to go into more detail with it or anything , feel welcome to reach out to us .

You can reach out to us via email at askaskatbulmanwealthcom . So that's A-S-K-A-B-U-L-M-A-N-WELFcom . So what we're going to do is we're going to start on the traditional side of the coin traditional iron , traditional 401k and a little bit about the history of them and what they mean . So the first thing I'll mention is this .

I always boil it down One way I like to understand it is 400 number accounts 401ks , 403bs , 457s are always attached to a workplace or an employer , even if it's a former employer say , you worked for XYZ company 10 years ago you might still have your 401k there . But the point is 400 number accounts are always attached to an employer or a workplace .

Iras , outside of one exception , with what's called a simple IRA , in the majority of cases IRAs are outside of the workplace , meaning something that you own on your own . So , with that understanding , we'll start with the oldest style of these accounts , of these four accounts we're going to talk about , and it's the traditional IRA and it was started in 1974 .

The traditional 401k started four years later , in 1978 . So the biggest difference between these ? Well , a couple differences . One , like I just mentioned , it depends on where they're located . So if you're still working , there's a very good chance you have a 401k or a comparable account at your workplace . So let's start there .

401ks , these traditional 401ks , these are plans offered by your workplace that allow you to put pre-tax contributions into the account and it defers taxes or puts them off to a later date . So what does that mean ? Let's just say Jane Doe . She's working as a nurse . She makes $100,000 a year .

If she contributes $10,000 into her traditional 401k , well , it's going in pre-tax , meaning 10,000 goes in over the course of the year and her income which we said was 100,000 , well , it's reduced by the amount that she contributes into her 401k . So in this case she makes 100,000 a year . She put $10,000 into her 401k in that given year .

Well , when she files taxes the following year it's gonna make it look like she made $10,000 less . So she'll be taxed on 90,000 . So that $10,000 that she invested ? Well , as we said , it's deferring taxes , meaning it's putting them off to a later date . So say , over time she's adding each year into this account .

Well , eventually , once you get into a certain age , which for these accounts is 59 and a half , once you're older than 59 and a half , you can start withdrawing from the account without penalty . So let's fast forward . Say Jane Doe's 65 and she's retired .

Well , if she's got half a million dollars in her 401k , everything she pulls out of it , say as a distribution , is taxed as income . So all of those taxes that she deferred all along the way . Well , guess what ? She's gonna start owing them now .

So , as she's pulling money out of this account , say , in a given year she pulls out $20,000 in her retirement Well , that year it'll look like her income is $20,000 higher . It's taxed as regular income . So you're deferring or delaying the taxes to a later date . So in one regard , hey , I need a tax break now .

I'm paying too much in taxes , which you know is a thorn in a lot of folks' sides . Well , you get the break now . With a traditional 401k . Some of you might be lucky enough to get a company match . What that means is , say John Doe's working and he's putting in $10,000 , well , he can get a company match .

We've seen those going anywhere from one to five , one to 6% . What that means is that company a match is that company is generally matching whatever you're putting in . So say he's putting in , their match is 3% . Say that's where it tops out . Well , in many instances John Doe would have to put in 3% of his own money that year to get the 3% match .

But it is always nice to get that match because it's free money . That's money . All you have to do is contribute a little to get that benefit of that match . So that's kind of it in a nutshell . With traditional 401ks you get a tax break now . So there's also what are called contribution limits .

So let's say you're listening to this in your 50 , or under the age of 50 . If that's you , in a given year you can put in up to $22,500 of your own money and contributions . That does not include the match . So that $22,500 , that's the ceiling . That does not include anything the company's matching .

So say , you put in 22 and a half , the company's matching 5% . Well , that's in addition to what you're putting in . So that's for anyone that is under the age of 50 . However , if you're over the age of 50 , they have a catch-up provision . These numbers have changed and they will continue to change , I think .

Well , right now , if you're over the age of 50 , you can put in $30,000 into $30,000 . Your traditional 401k so it allows you the company plan . You know the IRS . They allow you to put in $7,500 more . It's called the catch-up provision . So once you're over 50 , you can put in a good bit more . So these are 401ks . What's inside of a 401k ?

Generally and this isn't true in every case , but the majority of companies are going to have mutual funds that you can invest in . Every once in a while we've seen companies that will allow company stock , but you're investing in these accounts hoping for them to grow .

We've seen companies offer anywhere from 5 to 25 funds just a different collection of different areas of the market . But the biggest thing to remember it's through a workplace and you can contribute $22,500 a year If you're under 50 , over 50 , it's $30,000 . And , like we said , with a traditional 401k , you get a tax break now , but guess what ?

In the future you will have to pay taxes . Also , if you need money , 401ks allow for loans . So generally they'll allow a loan that you can take Some companies . You have to pay it back over a five-year span . As far as I understand , you can take up to 50% of the account , up to $50,000 , as a loan . So 401ks allow a loan .

Traditional IRAs , which we'll talk about in a second Don't , and I guess I'll mention this now in terms of there's a lot of parallels between traditional 401ks and traditional IRAs . Well , let's go to a traditional IRA . In IRA , an individual retirement account that's the acronym , or the acronym is IRA for that . These are accounts that are outside of a workplace .

So say you're just starting off or in want to start investing money , you might start in IRA . The contribution limits are tremendously different For a not a SEP IRA . That's a whole other discussion . I'll try to . I'll leave that out . Maybe I'll tackle that in a future podcast .

But just basic traditional IRAs if you're under the age of 50 , the contribution limit is 6,500 . If you're 50 or older it shoots up tremendously to 7,500 . There's a $1,000 difference . So it's dramatically different in terms of how much you can contribute . But as I said earlier , an IRA is always outside of a workplace .

So it's still a traditional IRA , still has that same tax deferral , meaning you're putting money in pre tax . So say John or Jane Doe puts in $5,000 into an IRA that year a traditional IRA well , their income is reduced by that amount , just like it is with the traditional 401k , and again you're deferring those taxes to a later date .

One thing that we see a lot about is a lot of times if someone and we see this all the time people changing jobs and say you work at an old employer , your 401k is still sitting there , a lot of folks will transfer that into an IRA Because again , once you do that say , you've got 100,000 in an old 401k a company you worked with eight years ago , for

example well , you can roll that into a traditional IRA . It does not create a taxable event . It's almost like moving from one pocket into the other . But what that does is A . You're going to work with an advisor , you know , like us , and generally it's gonna offer a lot more options to invest in . You know where the 401K .

You're kind of a prisoner to the limited amount of funds they offer Well , and IRA's gonna have a lot more because you have a much wider palette of things to select . So then , to the day , those are the big differences . With the traditional IRA , traditional 401K . The biggest difference is the contribution limits .

But , like I said a lot of times , if you didn't know you could do this , if you have old 401K's floating out there , you might wanna consider moving it into an IRA , a traditional IRA . So after what ? 12 minutes ? That's kind of traditional IRA's and 401K's in a nutshell . So then we segue into Roth IRA's and Roth 401K's .

So , as we mentioned earlier , the traditional IRA was introduced in 1974 . Well , the Roth IRA didn't come out until 1997 , a long time later . 23 years later , a Roth 401K came out nine years after that . They didn't come out till January 1st 2006 . So how do they differ ? Many of you probably know , and that's great . Some of you might think you know .

Some of you have no idea and you've always been afraid to ask . So where a Roth account differs is you're putting money in post tax . So what does that mean ? Well , let's start with just like the traditional IRA's , a Roth 401K is at a workplace . A Roth IRA is outside the workplace .

So say , we put $5,000 into a Roth IRA and they have , by the way , they have the exact same contribution limits as I mentioned earlier in the show with traditional IRA's and traditional 401K's . So , for example , going back , john Doe has a Roth IRA . He puts $5,000 in that year . Well , his taxes , his income , is not reduced by 5,000 . He pays the taxes then .

But here's the big difference he's getting the taxes out of the way now , but everything that he puts into the Roth , so all his contributions and all the gains , are tax-free forever . In my opinion , that's very powerful . I would imagine a lot of people would agree with this . I think tax rates are gonna go up over time .

So if we've got a lot of money in our traditional 401K . That is great , but you gotta remember at some point when you start pulling money out , you're gonna get taxed on all of it , and if it's at a higher tax rate , well , less of it is yours , more of it is Uncle Sam's .

So that's why you know one of the reasons I think a Roth IRA is more powerful . I use an analogy . Sometimes might seem a bit silly in explaining the difference between a Roth and a traditional , but let me I'll run it by you see your thoughts . So here's a scenario . You walk up to someone and they have a bag of apple seed . You got two options .

One is I'm gonna sell you the seed , I don't charge you any tax . Now you plant the seeds and orchard grows and all the apples that you pick I'm gonna tax you on that . So I don't tax you on the seed , I tax you on all the apples that grow . So that's option one . Option two is I'm gonna tax you on the seed now .

Then you plant the orchard and at that point all of the apples are yours . So you pay taxes on the seed now , plant it , all the apples and all the fruit is yours . That's option two . Well , option one is a traditional IRA or traditional 401k . Option two is the Roth .

Generally , from my experience , when I give those examples of someone , they say I like the second one better , again , because it's about the taxes . So , say , you have a Roth 401k outside of work or a Roth IRA outside of work , sorry , well , you're putting in post tax . Here's the thing , though Roth IRAs are very powerful , but there are income limitations .

So what does that mean ? Income limitations ? Well , let's just say , for example , a married couple filing taxes jointly . Well , if their income is over 228,000 combined , well , they can get phased out of a Roth IRA . So , as powerful as the tool as it is , it can get phased out for the higher income earners . So then we look at okay , what is a Roth 401k ?

Again , this is the last account of the four that was introduced to the mix back in 2006 . What I love about Roth 401ks is you can do it all through your work and the contribution limits are so much higher . Just like with the traditional IRA , if you're over the age of 50 , a Roth IRA , you can only put in 7500 a year , and there's income limitations .

Roth 401k you can put in 30,000 a year and there's no income limitations . So again , it's such a powerful tool . You can do it through your workplace . A lot of people don't even know that they have a Roth 401k . I meet with folks and I tell them hey , do you know if you have one ? I don't know , go ask if you're still working there .

I saw a stat CNBC did a study in the fall of 2022 . And they said 88% of employers now offer a Roth 401k . So this is certainly something worth looking into if you're still working , because of that tax-free nature Because , again , if you're putting the , you get the taxes out of the way .

Now you put the money in everything you put in , plus , their growth is all yours . It doesn't matter how much taxes increase in the future . And again , to me that's a very powerful tool . I get a question a lot hey , well , you know , how does a Roth account grow versus a traditional ? I said it doesn't matter , it's , you can invest it the exact same way .

One doesn't grow better or earn better interest versus the other . It's all about what you have it invested in . The biggest difference , as we've learned , is the tax ramifications of it . So , as I said a few minutes ago , if you're not sure , if say you're still working and you're not sure .

If you have a Roth 401k , I would go ask and if you don't have one , I would ask why not ? Why are we one of the 12% of companies that doesn't have a Roth 401k ? So we could go further into the weeds with the Sepirahs and Roth conversions . That's something I think I've tackled on at least Roth conversions and past podcast .

Today I just wanted to go over the basic overview of the differing accounts the traditional IRA and traditional 401k and how those compare with the Roth IRA and the Roth 401k . Again , if anything you heard prompts more questions , feel welcome to reach out to us . Ask at BowmanWolfcom If you are hearing this and want to leave a review .

By all means , wherever you're listening to it , feel welcome to leave a review . And also , with that , ask at BowmanWolf email . If you have a show subject like hey , I've got a question about X topic , shoot us a recommendation . We're always open to those . But nonetheless , thank you for listening . I hope you learned something .

I try to keep these lean and mean and enjoy the rest of your day and we will talk to you next time . Thank you .