When I was in my 20s, I don’t think I uttered the word retirement. It was just not something I ever thought about.  I remember my best friend referred to one of her friends as very financially responsible. “She maxed out her 401k." That’s the extent of what I knew about retirement. I thought you needed to be a full-time employee; otherwise, you don’t get to retire.

I opened my first retirement account two years after starting my financial freedom journey. It felt totally unachievable before than, even though it wasn't, which I know now. Retirement is truly one of my favorite things to talk about now.

But AJ, why?

Planning for retirement is like planting a financial tree that will provide shade and comfort in your golden years. But it’s so much more than that. It’s an entire forest of shade, oxygen, and protection. That forest sets up your entire family for financial success. 

This will be blog post ONE. Before we dive into the different types of accounts, we must understand the difference between a ROTH and TRADITIONAL.

Roth vs. Traditional Retirement Accounts: Which is Right for You?

When planning for your retirement, one of the fundamental decisions you'll need to make is whether to invest in a Roth or Traditional retirement account. Both options offer distinct advantages and tax implications, so let's break down the differences:

Traditional Retirement Accounts:

•  Tax Implications:
  •  Tax-Deductible on Contributions (You get to save money on taxes TODAY) Contributions (What you put into the account) to a Traditional retirement account are tax-deductible in the year you make them. This means you can reduce your taxable income, potentially lowering your immediate tax bill.
  •  Tax-Deferred Growth (you pay tax on what you earn LATER): Any earnings on your investments within the account grow tax-deferred until you withdraw them in retirement. This means you don't pay taxes on the gains each year.
 
•  Withdrawals in Retirement:
  •  Taxed as Income: When you withdraw funds from a Traditional retirement account in retirement, those withdrawals are treated as taxable income. You'll pay income tax on the amount you withdraw.
 
•  Required Minimum Distributions (RMDs):
  •  RMDs Required: Starting at age 72 (or 70½ for those who turned 70½ before January 1, 2020), you must take Required Minimum Distributions (RMDs) from Traditional retirement accounts each year. These withdrawals are subject to income tax.
 
•  Who May Benefit:
  •  Lower Tax Bracket in Retirement: Traditional accounts can be advantageous if you expect to be in a lower tax bracket in retirement than you are during your working years.
 

Roth Retirement Accounts:

•  Tax Implications:
  •  Not Tax-Deductible (You don’t save on taxes today, but don't pay taxes IN THE FUTURE): Contributions to Roth retirement accounts are made with after-tax dollars. You don't get an immediate tax deduction for contributing.
  •  Tax-Free Growth (You pay NO taxes): Earnings on investments within a Roth account grow tax-free, and you won't owe taxes on the gains when you withdraw them in retirement. 
•  Withdrawals in Retirement:
  •  Tax-Free: Qualified withdrawals from Roth retirement accounts in retirement are entirely tax-free. This includes both your contributions and your earnings.
 
•  No RMDs:
  •  No RMDs Required: Roth IRAs do not have required minimum distributions (RMDs) during the account holder's lifetime. This flexibility can be advantageous for retirement planning and estate planning.
 
•  Who May Benefit:
  •  Expecting Higher Taxes in Retirement: Roth accounts can be attractive if you anticipate being in a higher tax bracket in retirement or want to maximize tax-free income in retirement.
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Impact on Your Take-Home Pay: Roth vs. Traditional

One essential factor to consider when deciding between Roth and Traditional retirement accounts is how each choice affects your current take-home pay. This decision can influence your monthly budget and financial flexibility.

Traditional Retirement Accounts: Choosing a Traditional retirement account can immediately benefit your monthly take-home pay. Contributions to Traditional accounts are tax-deductible, which means your taxable income for the year is reduced. As a result, you may experience a lower tax withholding on your paycheck, leading to a higher net income.

Roth Retirement Accounts: On the other hand, contributions to Roth retirement accounts are made with after-tax dollars, offering no immediate tax deduction. This choice results in a slightly lower net income compared to contributing to a Traditional account since you're not reducing your taxable income during your working years.

Long-Term Consideration: While the impact on your take-home pay is important, it's crucial to consider both the short and the long-term tax implications. The short-term consideration should take into account your most immediate personal and financial goals, like if you’re working towards saving for a home 🏠 or in a big life transition: moving, having kids, adding another car, etc. Caring for an elderly parent can be another factor. Would having more cash on hand be more valuable, or can you support your lifestyle + goals with less money?

When thinking long-term, traditional account contributions are tax-deductible now, but withdrawals in retirement are subject to income tax. In contrast, Roth account contributions are made with after-tax dollars, but qualified withdrawals in retirement are entirely tax-free, potentially leading to a more tax-efficient retirement. 

Ultimately, the decision between Roth and Traditional retirement accounts should align with your current financial situation, future income expectations, and long-term retirement goals. Balancing your take-home pay today with tax-free income in retirement is a key consideration when making this choice. Consulting with a financial planner will help you navigate these trade-offs and make the best decision for your unique circumstances. Working with a finance coach will help you clean up your day-to-day spending, give you the financial confidence to navigate these conversations, and help you achieve your short and long-term goals.

Be sure to read - Part Two: Different types of retirement accounts.

Disclaimer: This website and its content is owned by Beyond The Green Coaching. AJ Schneider and the Financial Freedom Coaches are NOT financial planners, attorneys, accountants, therapists, counselors or psychologists. The information on this website and in the resources provided is for educational and informational purposes only. You acknowledge that you are participating voluntarily in using our resources, and you are personally responsible for any choices, actions and outcomes now and in the future. Before making any financial or investment decisions, we recommend you consult a financial planner. Beyond The Green Coaching is not liable for any errors or omissions of information supplied in these materials.