Traditional Vs Roth Accounts: Which Is Right For You?

Welcome back to Your Financial Compass! In today’s episode, we’re diving into the key distinctions between Traditional and Roth IRAs and 401(k)s. If you've ever wondered about the differences, pros, and cons, this episode is your guide to understanding these essential financial instruments.

Here’s some of what we discuss in this episode:

• What are the differences between traditional IRAs and traditional 401(k)s, and how do they work?
• How do Roth IRAs and Roth 401(k)s differ from their traditional counterparts?
•  What are the potential benefits of using a Roth account, and are there any income limitations?
• Can you transfer old 401(k) accounts into traditional IRAs without tax consequences?

Resources for this episode

Check out the CNBC article on 401(k)s

WAYS TO CONNECT:

Book a 15-minute discovery call with the team here: https://calendly.com/rachel-bwg

Visit https://bulmanwealth.com/marcos-lemus to learn more about Marcos Lemus and the other members of the team.

If you have any questions about what we discussed or anything else in your financial plan, email us at [e-mail]. You can also reach the team by phone at [phone].

Episode Transcript

Speaker 1 (00:03):
Welcome.
You are listening to theFinancial Compass podcast
presented by the Bowman WealthGroup.
These shows are designed toprovide information to both pre
and post-retirees so they may beable to make more informed
decisions about their financialfuture.
Our Financial Compass processgoes beyond traditional holistic
financial planning.
We care as much about you andyour lifestyle as we do about

(00:26):
your plan.
At the Bowman Wealth Group, wewant to help you define what
matters most and inspire you togo and do it.
Your host is Bowman WealthGroup financial advisor Scott
Vellon, who, for more than adecade, has provided financial
leadership for those he serves.

Speaker 2 (00:43):
Hello and welcome to the your Financial Compass
podcast.
My name is Scott Vellon.
I'm a financial advisor inRoseville, california, and I
appreciate anyone who'slistening to this.
I get a lot of feedback, folksreaching out, and I really
appreciate that people arehearing this and getting value
from it.
If this is your first time,welcome.

(01:06):
Each episode we tackle adifferent topic and do a little
deep dive into it.
Some of it might be basic andsome of it might be really
in-depth.
Everyone has a differentunderstanding of financial
concepts so I try to keep iteasy to understand, easy to
grasp for the folks that aren'tsuper in-depth or under in their
knowledge of finances.

(01:27):
This episode is going to beabout traditional iras and Roth
iras traditional 401ks and Roth401ks what are they?
What are the differences?
What are the pros and cons?
What does it all mean?
As I always say, if anythingyou hear prompts more questions

(01:48):
or you want to go into moredetail with it or anything, feel
welcome to reach out to us.
You can reach out to us viaemail at askaskatbulmanwealthcom
.
So that'sA-S-K-A-B-U-L-M-A-N-WELFcom.
So what we're going to do iswe're going to start on the

(02:12):
traditional side of the cointraditional iron, traditional
401k and a little bit about thehistory of them and what they
mean.
So the first thing I'll mentionis this.
I always boil it down One way Ilike to understand it is 400

(02:32):
number accounts 401ks, 403bs,457s are always attached to a
workplace or an employer, evenif it's a former employer say,
you worked for XYZ company 10years ago you might still have
your 401k there.
But the point is 400 numberaccounts are always attached to

(02:54):
an employer or a workplace.
Iras, outside of one exception,with what's called a simple IRA
, in the majority of cases IRAsare outside of the workplace,
meaning something that you ownon your own.
So, with that understanding,we'll start with the oldest
style of these accounts, ofthese four accounts we're going

(03:16):
to talk about, and it's thetraditional IRA and it was
started in 1974.
The traditional 401k startedfour years later, in 1978.
So the biggest differencebetween these?
Well, a couple differences.
One, like I just mentioned, itdepends on where they're located

(03:37):
.
So if you're still working,there's a very good chance you
have a 401k or a comparableaccount at your workplace.
So let's start there.
401ks, these traditional 401ks,these are plans offered by your
workplace that allow you to putpre-tax contributions into the

(04:00):
account and it defers taxes orputs 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 intoher traditional 401k, well,

(04:20):
it's going in pre-tax, meaning10,000 goes in over the course
of the year and her income whichwe said was 100,000, well, it's
reduced by the amount that shecontributes into her 401k.
So in this case she makes100,000 a year.
She put $10,000 into her 401kin that given year.

(04:42):
Well, when she files taxes thefollowing year it's gonna make
it look like she made $10,000less.
So she'll be taxed on 90,000.
So that $10,000 that sheinvested?
Well, as we said, it'sdeferring taxes, meaning it's
putting them off to a later date.
So say, over time she's addingeach year into this account.

(05:05):
Well, eventually, once you getinto a certain age, which for
these accounts is 59 and a half,once you're older than 59 and a
half, you can start withdrawingfrom the account without
penalty.
So let's fast forward.
Say Jane Doe's 65 and she'sretired.
Well, if she's got half amillion dollars in her 401k,

(05:26):
everything she pulls out of it,say as a distribution, is taxed
as income.
So all of those taxes that shedeferred all along the way.
Well, guess what?
She's gonna start owing themnow.
So, as she's pulling money outof this account, say, in a given
year she pulls out $20,000 inher retirement Well, that year

(05:49):
it'll look like her income is$20,000 higher.
It's taxed as regular income.
So you're deferring or delayingthe taxes to a later date.
So in one regard, hey, I need atax 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 luckyenough to get a company match.

(06:12):
What that means is, say JohnDoe's working and he's putting
in $10,000, well, he can get acompany match.
We've seen those going anywherefrom one to five, one to 6%.
What that means is that companya match is that company is
generally matching whateveryou're putting in.
So say he's putting in, theirmatch is 3%.

(06:35):
Say that's where it tops out.
Well, in many instances JohnDoe would have to put in 3% of
his own money that year to getthe 3% match.
But it is always nice to getthat match because it's free
money.
That's money.
All you have to do iscontribute a little to get that
benefit of that match.
So that's kind of it in anutshell.

(06:57):
With traditional 401ks you get atax break now.
So there's also what are calledcontribution limits.
So let's say you're listeningto this in your 50, or under the
age of 50.
If that's you, in a given yearyou can put in up to $22,500 of

(07:18):
your own money and contributions.
That does not include the match.
So that $22,500, that's theceiling.
That does not include anythingthe company's matching.
So say, you put in 22 and ahalf, the company's matching 5%.
Well, that's in addition towhat you're putting in.

(07:39):
So that's for anyone that isunder the age of 50.
However, if you're over the ageof 50, they have a catch-up
provision.
These numbers have changed andthey will continue to change, I
think.
Well, right now, if you're overthe age of 50, you can put in
$30,000 into $30,000.

(08:01):
Your traditional 401k so itallows you the company plan.
You know the IRS.
They allow you to put in $7,500more.
It's called the catch-upprovision.
So once you're over 50, you canput in a good bit more.
So these are 401ks.
What's inside of a 401k?
Generally and this isn't truein every case, but the majority

(08:23):
of companies are going to havemutual funds that you can invest
in.
Every once in a while we'veseen companies that will allow
company stock, but you'reinvesting in these accounts
hoping for them to grow.
We've seen companies offeranywhere from 5 to 25 funds just
a different collection ofdifferent areas of the market.
But the biggest thing toremember it's through a

(08:46):
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 atraditional 401k, you get a tax
break now, but guess what?
In the future you will have topay taxes.
Also, if you need money, 401ksallow for loans.

(09:07):
So generally they'll allow aloan that you can take Some
companies.
You have to pay it back over afive-year span.
As far as I understand, you cantake up to 50% of the account,
up to $50,000, as a loan.
So 401ks allow a loan.
Traditional IRAs, which we'lltalk about in a second Don't,

(09:27):
and I guess I'll mention thisnow in terms of there's a lot of
parallels between traditional401ks and traditional IRAs.
Well, let's go to a traditionalIRA.
In IRA, an individualretirement account that's the
acronym, or the acronym is IRAfor that.
These are accounts that areoutside of a workplace.
So say you're just starting offor in want to start investing

(09:51):
money, you might start in IRA.
The contribution limits aretremendously 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 afuture podcast.
But just basic traditional IRAsif you're under the age of 50,
the contribution limit is 6,500.

(10:13):
If you're 50 or older it shootsup tremendously to 7,500.
There's a $1,000 difference.
So it's dramatically differentin terms of how much you can
contribute.
But as I said earlier, an IRAis always outside of a workplace
.
So it's still a traditional IRA, still has that same tax

(10:37):
deferral, meaning you're puttingmoney in pre tax.
So say John or Jane Doe puts in$5,000 into an IRA that year a
traditional IRA well, theirincome is reduced by that amount
, just like it is with thetraditional 401k, and again
you're deferring those taxes toa later date.

(10:58):
One thing that we see a lotabout is a lot of times if
someone and we see this all thetime people changing jobs and
say you work at an old employer,your 401k is still sitting
there, a lot of folks willtransfer that into an IRA
Because again, once you do thatsay, you've got 100,000 in an

(11:19):
old 401k a company you workedwith eight years ago, for
example well, you can roll thatinto a traditional IRA.
It does not create a taxableevent.
It's almost like moving fromone pocket into the other.
But what that does is A.
You're going to work with anadvisor, you know, like us, and

(11:39):
generally it's gonna offer a lotmore options to invest in.
You know where the 401K.
You're kind of a prisoner tothe limited amount of funds they
offer Well, and IRA's gonnahave a lot more because you have
a much wider palette of thingsto select.
So then, to the day, those arethe big differences.
With the traditional IRA,traditional 401K.

(12:00):
The biggest difference is thecontribution limits.
But, like I said a lot of times, if you didn't know you could
do this, if you have old 401K'sfloating out there, you might
wanna consider moving it into anIRA, a traditional IRA.
So after what?
12 minutes?
That's kind of traditionalIRA's and 401K's in a nutshell.

(12:21):
So then we segue into Roth IRA'sand Roth 401K's.
So, as we mentioned earlier,the traditional IRA was
introduced in 1974.
Well, the Roth IRA didn't comeout until 1997, a long time
later.
23 years later, a Roth 401Kcame out nine years after that.

(12:46):
They didn't come out tillJanuary 1st 2006.
So how do they differ?
Many of you probably know, andthat's great.
Some of you might think youknow.
Some of you have no idea andyou've always been afraid to ask
.
So where a Roth account differsis you're putting money in post
tax.

(13:07):
So what does that mean?
Well, let's start with just likethe traditional IRA's, a Roth
401K is at a workplace.
A Roth IRA is outside theworkplace.
So say, we put $5,000 into aRoth IRA and they have, by the
way, they have the exact samecontribution limits as I

(13:27):
mentioned earlier in the showwith 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, isnot reduced by 5,000.
He pays the taxes then.
But here's the big differencehe's getting the taxes out of

(13:48):
the way now, but everything thathe puts into the Roth, so all
his contributions and all thegains, are tax-free forever.
In my opinion, that's verypowerful.
I would imagine a lot of peoplewould agree with this.
I think tax rates are gonna goup over time.
So if we've got a lot of moneyin our traditional 401K.

(14:10):
That is great, but you gottaremember at some point when you
start pulling money out, you'regonna 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 ofthe reasons I think a Roth IRA
is more powerful.
I use an analogy.

(14:30):
Sometimes might seem a bitsilly in explaining the
difference between a Roth and atraditional, but let me I'll run
it by you see your thoughts.
So here's a scenario.
You walk up to someone and theyhave a bag of apple seed.
You got two options.
One is I'm gonna sell you theseed, I don't charge you any tax
.
Now you plant the seeds andorchard grows and all the apples

(14:56):
that you pick I'm gonna tax youon 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 youon the seed now.
Then you plant the orchard andat that point all of the apples

(15:16):
are yours.
So you pay taxes on the seednow, plant it, all the apples
and all the fruit is yours.
That's option two.
Well, option one is atraditional IRA or traditional
401k.
Option two is the Roth.
Generally, from my experience,when I give those examples of
someone, they say I like thesecond one better, again,

(15:38):
because it's about the taxes.
So, say, you have a Roth 401koutside of work or a Roth IRA
outside of work, sorry, well,you're putting in post tax.
Here's the thing, though RothIRAs are very powerful, but
there are income limitations.
So what does that mean?
Income limitations?
Well, let's just say, forexample, a married couple filing

(15:58):
taxes jointly.
Well, if their income is over228,000 combined, well, they can
get phased out of a Roth IRA.
So, as powerful as the tool asit is, it can get phased out for
the higher income earners.
So then we look at okay, whatis a Roth 401k?
Again, this is the last accountof the four that was introduced

(16:19):
to the mix back in 2006.
What I love about Roth 401ks isyou can do it all through your
work and the contribution limitsare so much higher.
Just like with the traditionalIRA, if you're over the age of
50, a Roth IRA, you can only putin 7500 a year, and there's
income limitations.
Roth 401k you can put in 30,000a year and there's no income

(16:42):
limitations.
So again, it's such a powerfultool.
You can do it through yourworkplace.
A lot of people don't even knowthat they have a Roth 401k.
I meet with folks and I tellthem hey, do you know if you
have one?
I don't know, go ask if you'restill working there.
I saw a stat CNBC did a studyin the fall of 2022.

(17:03):
And they said 88% of employersnow offer a Roth 401k.
So this is certainly somethingworth looking into if you're
still working, because of thattax-free nature Because, again,
if you're putting the, you getthe taxes out of the way.
Now you put the money ineverything you put in, plus,

(17:26):
their growth is all yours.
It doesn't matter how muchtaxes increase in the future.
And again, to me that's a verypowerful tool.
I get a question a lot hey, well, you know, how does a Roth
account grow versus atraditional?
I said it doesn't matter, it's,you can invest it the exact
same way.
One doesn't grow better or earnbetter interest versus the

(17:49):
other.
It's all about what you have itinvested in.
The biggest difference, aswe'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'renot sure.
If you have a Roth 401k, Iwould go ask and if you don't
have one, I would ask why not?

(18:10):
Why are we one of the 12% ofcompanies that doesn't have a
Roth 401k?
So we could go further into theweeds with the Sepirahs and
Roth conversions.
That's something I think I'vetackled on at least Roth
conversions and past podcast.
Today I just wanted to go overthe basic overview of the

(18:30):
differing accounts thetraditional IRA and traditional
401k and how those compare withthe Roth IRA and the Roth 401k.
Again, if anything you heardprompts more questions, feel
welcome to reach out to us.
Ask at BowmanWolfcom If you arehearing this and want to leave
a review.
By all means, wherever you'relistening to it, feel welcome to

(18:53):
leave a review.
And also, with that, ask atBowmanWolf email.
If you have a show subject likehey, I've got a question about
X topic, shoot us arecommendation.
We're always open to those.
But nonetheless, thank you forlistening.
I hope you learned something.
I try to keep these lean andmean and enjoy the rest of your

(19:14):
day and we will talk to you nexttime.
Thank you.

Speaker 1 (19:45):
Thank you, Chris Blumen Inc.

(20:15):
Dba BWG Insurance Agency.