Tom Talks Pros and Cons of IRAs vs Taxable Accounts
Transcript:
Easan Arualanantham:
In the day before, tax day, my accountant told me I could contribute $7,000 to my Roth IRA, I haven’t set up an IRA or Roth. And now I’m trying to learn more about them, you know, what’s the pros and cons of a Roth IRA versus a regular traditional IRA? And or just a regular brokerage? And is there any advantage to having both of them or having it kind of stretch across the three? What are your opinions?
Tom Vaughan:
Okay, so there’s a couple questions that are really so one is about when you can contribute to a Roth IRA, for example. And it is kind of interesting, because a Roth is different than a regular IRA, regular IRA. With a Roth, there’s an income limit, for you know how much you can make. And so if you put money in a Roth, and you happen to exceed those limits, the limit right now, or I believe, they start phasing out at about 198,000. For a couple, and 125,000 for a single person. And if you exceed those limits, and put in too much actually can get penalised, it’s a 6% penalty per year. So putting in a Roth before, you know for sure what your incomes are going to be, can be a little bit dangerous in that respect. Now, if you know for sure, you’re not going to be above those income limits, then you really want to put the money in as soon as possible, which would be January 1 of that year. But otherwise, you want to wait until after your taxes are, you know, being prepared.
So you really do know the income, and you would make that contribution up until April 15 of the following year. So for example, if I want to make a contribution for 2021, I can wait till April 15 of 2022, to make that contribution. But it’s a little bit different in that regard, because there is an income limitation that you have to be careful with. Now, the other aspect is just comparing question part here was comparing a regular IRA versus a Roth IRA versus a regular account, call it a taxable account. And, really, it’s kind of interesting. So a regular IRA grows, without any taxes until you withdraw called tax deferred. a Roth IRA grows without any taxes, and then you don’t have to take anything out pay any taxes when you take it out. That’s tax free. All right. But both of those have a penalty for taking money out before 59 and a half, right.
And so that’s one thing to consider versus a taxable account, you have no penalties for getting that money out of there. A regular IRA will give you a write off. So if you’re desperate for a ride off, that would be a better choice. In my opinion, if I’m choosing between a regular IRA and a Roth IRA, I’m going to choose the Roth IRA, I’ve already converted all of my regular IRAs over to Roth, I’ve converted my 401k to only 401k. Roth, I’m everything I have, I have no future tax liability on my on my retirement accounts, mainly because I’ve seen what happens to everybody that ends up with a bunch of money in their regular 401k is a regular IRA. So that would be my choice between the Roth and the regular. And then the taxable account would be fairly equal to the Roth, as far as I’m concerned, I want to build assets up into both of those areas.
So if I had to choose between the three, I would choose a Roth IRA. And I would continue to add to a regular taxable account to build up that liquid asset, because that regular taxable account only has a capital gain that I have to pay, which is lower than normal taxes, as long as I hold on to it for a year. So that would be the best tax structure. And I think the best flexibility is a regular, you know, a Roth IRA sorry, and a, you know, taxable account together. And I think that, you know, is a winning strategy as far as that goes. So, yeah, it’s, it’s, it’s one of those things that’s a little bit confusing in today’s world, and it does keep changing. But that’s, that’s what I’d be recommending today.
Easan Arulanantham:
So I’ve heard some things when trying to set up a Roth IRA for your child, is there any things that you would like do for that?
Tom Vaughan:
I know they have to have income just to do? What’s the biggest challenge, they have to have income. I mean, it’s pretty awesome concept to think, Oh, I got this two year old, I could put $6,000 a year, you know, into this Roth IRA for them, just keep doing it and doing it. And then they could take over and do it themselves. Oh, my gosh, it’s amazing, you know, tax free, massive amounts of money by the time they get to retirement. And the statistics are unbelievable, you know, when somebody started saving in their 20s versus their 30s or 40s or 50s. It’s It’s It’s incredible how much more money but you have to have income. And so, you know, it’s very hard to justify, you know, and you know, even if you have your own business employing your two year old, so, you know, once your child does get a job, and you know, you can contribute, I mean, my daughter had a 13 $180, in 2019 of income from the pizza place she was working out. So she could put $1,380 into a Roth IRA, that max she could do is $6,000. But the, it’s either the $6,000, or what you earn, whichever one is lower. So for her, it’s $1,380. So, yeah, that’s one of the issues with trying to do this for kids, is just that aspect of, you know, needing earnings.
One thing you could do, and I have done this for a couple clients, you could just set up a regular taxable account, start putting money in there, and it’s in your name and what have you, but it’s mentally it’s for your kids, and you’re building that up. And then once they get a job, you just use that money to kind of fund their, you know, match their pay up to $6,000. And just keep putting that money slowly but surely into Roth IRAs. And so that, you know, it’s a way to, so at two years old, you could start saving for that kid and for that Roth IRA in a in a in a separate account. There’s some tax issues and what have you, but that’s that’s a strategy I’ve actually used with a couple clients. They’re very interested in trying to make sure their kids are well set up in retirement. You could do the same types of things with college planning too, but that’s a different story.