In Financial Planning I have discussed how pertinent it is to have defensive strategies in place, think of them as your Ray Lewis, but today I’m going to touch on the difference between some offensive financial vehicles. This article will delve into both 401k’s and Roth IRA’s, including their tax implication, limitations, penalties, and ultimately how to utilize them most effectively.
A 401k is a retirement account that is set up through your employer. The employer takes the money out of your paycheck and puts the funds into the 401k prior to calculating income taxes for your income. In other words, 401k contributions reduce your taxable income. The money in the 401K is tax deferred, not tax exempt. This means that when you withdraw the money, you will have to pay tax on it. The catch comes with age minimums for withdrawal. Any withdrawals before 591/2 are subject to a 20% penalty on top of your tax bracket. This is an advantageous way to save and accrue wealth during your working years, but you have to know how to use it. During times when a conservative is leading the country and taxes are lower on capital gains and the wealthy, one should draw from their 401k. On the other hand, with a liberal in office, the Roth IRA is a more appealing vehicle.
Your Roth IRA is a tax-advantaged investment vehicle. View it like you would a bank account, except just a bit stricter, more rules. One thing that separates a Roth IRA Explained from almost all other investments is the tax treatment. The tax treatment in a Roth IRA is spectacular. So you get paid by your job, they take the taxes out, you use that after-tax money and put it in your Roth. Then you’re able to invest to your heart’s desire, and when you take the money out at the end, there are no taxes assessed. None. Seriously. In general, whatever amount of money you put into it, you can take out of it at any time, with no questions asked. The only time one would be penalized would occur during a draft amount greater than what has been contributed, the interest. The final rule that applies with Roth IRA’s is the annual contribution limit. Individuals are limited to a annual input of $5,500. This rewards those who start young.
It’s obvious that each vehicle has it’s advantages, and there’s specific times to utilize one or the other.
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