Episode 42: How Investing in an IRA Can Help You Prepare for Retirement
Jul 28, 2023
On this episode of Wright Money Tips, Isaac Wright, CFP®, ChFC® and Ricky Lafon, MBA, CFP®, RICP®, WMCP® discuss the benefits of a traditional IRA and Roth IRA and how these investment options can be used to diversify your financial portfolio and help you achieve your lifestyle and retirement goals.
Here are just a handful of the things that we'll discuss:
- The differences between a traditional IRA and Roth IRA
- The tax advantages of an IRA
- Converting your workplace retirement accounts
- How diversifying your portfolio can help you prepare for retirement
- The benefits of working with a financial professional
Isaac Wright: Welcome back to Wright Money Tips. We are in the middle of summer. And through the summer and early fall for the next two to three episodes, we’re going to talk about the basic building blocks of people’s finances. And today we’re going to specifically focus on what is an IRA.
A lot of people know that term. They understand that they can put money away for retirement. But on today’s program, Ricky, I think this is going to be a really nice way just to introduce and also maybe discuss one or two topics around the word IRA that people are not necessarily familiar with. But glad to have you on the program today.
Ricky Lafon: Thanks for having me. Appreciate it.
Isaac Wright: Well, let’s just go ahead and get off the ground here with things that we take for granted, but maybe others do not. And what exactly is an IRA?
Ricky Lafon: Great place to start. So IRA is like an umbrella term. There’s two types of IRAs: you have a traditional IRA and you have a Roth IRA. But just think about whether you have a traditional or Roth, it’s an individual retirement account. We’ve got some clients who are blessed to have a 401(k), some clients might not have a 401(k), or maybe they’re self-employed. It’s a great way to save for retirement, maybe even have some tax advantages that are allowed by the IRS along the way.
Isaac Wright: Well, you know, when we talk about the IRAs in the world of being able to put money away for retirement, the vehicles that we typically see through a workplace plan. A lot of you, if you have a job that offers a 401(k), if you’re a government worker or maybe a state worker, you have a 457 plan, 403B, but IRAs predominantly, the reason we talk about IRAs is when people get to a certain age, they have the ability to roll that money into an individual retirement account that may give them some advantages.
But we don’t want to ever take for granted the fact that people understand when we talk about the word IRA, I guess the difference between an IRA, which is like you said, an individual retirement account, money can be put into it for your future, how does the taxes work? And maybe how does the taxes work with a Roth IRA?
Ricky Lafon: Great question. So, the traditional IRA, you can put money into and accumulate that and use that for your retirement. Of course, we can’t take it out until age 59 and a half or until you retire. But you can have some tax advantages of putting money into a traditional IRA. So, the IRS rewards you for saving for yourself for retirement.
Now, if I look at a Roth IRA, the other type of IRA is sort of the opposite. You can put money into it. There’s no tax advantage today of doing so. But if it sits there and grows, by the time you’re 59 and a half or retire, or if you retire later than that, you can take money out of that potentially 100% tax free. So that’s a huge advantage of having that as a mix of your retirement plan.
Isaac Wright: So in other words, the traditional IRA allows you to take a tax deduction potentially up front. With you kicking the can down the road for all of you watching this, moving that tax into the future at some point, and Lord knows how that’s going to be taxed is always the big question, the Roth IRA gives you the ability to pay the tax today.
And if you play by certain rules, you don’t have to worry about the taxes in the future. And so if you’ve heard us in past episodes, talk about what I would call tax diversification and having money that would be tax free in the future versus maybe having to pay a large amount of tax in the future, these are all those basic concepts and the type of accounts that are set up that give you some of that tax diversification.
I guess Ricky on that note, when would it make sense or potentially make sense to roll money into an IRA from another retirement plan? So when people hear this and I think you all should listen to this. You know, we talk about rolling money over a lot. But again, we don’t want to assume that you know what that means, rolling over money to an IRA. Talk to me a little bit about that.
Ricky Lafon: Yeah, you know, we’ve got some great options for that. So if you’ve got that 401(k), that 457 plan, what have you, you have the availability to move it over while you’re working or maybe you’ve retired and completely separated from service, you may want to consider moving that into an IRA because you’re going to have many more investment options to invest in.
401(k)s have been famous over the years for having a number of investment options, but they have basically shrunk over time because that’s a cost to the company that harbors that 401(k) plan. And so I’ve seen 401(k) plans literally with as few as five investment options. That may not just be the best for the client.
Isaac Wright: Gotcha. Well, I think that kind of does help summarize it. And, you know, just to be fair here, and there are moments and there are situations where it may make sense to leave the money in the workplace retirement plan.
Again, a lot of variations to this, whether or not, again, you’re old enough. You mentioned 59 and a half. Well, 59 and a half, you can still pull money out of a retirement account earlier than that, but you got to pay a penalty. So I know where you’re going there. You also got to keep in mind this, though, there are certain circumstances where you can access money from a workplace plan before 59 and a half without a penalty.
So that could be an example of why you may want to leave it in the workplace. Overwhelmingly, though, we have found that many people want to have a lot more flexibility with their investment options. And today, people work longer, or at least want to have the ability to work longer whether they need the income or not.
And so what happens is that IRA becomes a larger institution of where you want to normally have money because of those reasons. It gives you that greater flexibility, long-term investment approaches that you maybe not have the breadth of in a 401(k) or workplace plan. So, I know it’s hard to cover it all, but when we talk about rolling money over, just keep in mind, we can also help you determine when rolling money over makes sense. And also where that money may want to reside. Whether again, if it’s a traditional IRA or converting money from an IRA to a Roth IRA. So when people hear that term converting or conversion, let’s talk about what that means.
Ricky Lafon: Yeah, that’s something that’s really neat that’s allowed by the IRS. Some people may be in a blessed situation where they make too much money to add to that Roth IRA, that IRA that may be tax free in retirement.
So they’re putting money into a normal IRA, where you can convert that to that tax free Roth IRA. But you have to pay taxes on that money you’re moving over today at today’s rates.
So, if we’re going through a market downturn, if we’re going through a situation where a person’s retiring earlier than expected, maybe even a younger client that has some sort of gap in employment history, those are great times to take a look at Roth conversions and moving that money from that taxable traditional IRA over to that non-taxable Roth IRA.
Isaac Wright: Yeah. And if you listen to what Ricky’s covering here today, the number one thing he kind of said that I want people to understand is, you may have the ability, if it’s a market correction, or stock maybe has taken a hit, to convert that to a Roth IRA. Pay the tax today, so when that stock comes back, you have that money in a position where you’ve already paid the tax at a lower rate or a lower amount.
Again, things that we take for granted may be necessarily, you may not know when it comes to converting money. I think that’s a big issue.
Anything else you want to say around IRAs? Roth IRAs? It can be a lengthy topic, but I think, you know, we talk about what the situation is around an IRA versus a Roth. I think you guys also need to know when it comes down to the tax benefits of whether or not to set that up front, we can help.
Number two, the conversions, the rollovers, these are all going to be topics that I think in a show that we have here today, just introducing some of the basics of why it’s important to work with a financial advisor and a planner that has a good background in retirement planning.
But Ricky, anything you want to add to what we’re covering today?
Ricky Lafon: No, I think you’ve done a good job. And I don’t think that we want to get too far down in the weeds with this, but no. In working with a financial advisor, a financial planner, our software helps us take a look at the tax ramifications of doing some of these moves, whether you invest in a traditional IRA, Roth IRA, or convert it. And our job is to take a look at your holistic situation.
And let’s say we want to make a recommendation. It makes sense to move from that traditional IRA to the Roth. What are the tax ramifications of doing something like that?
Now, we’ll give a high level estimate, and we’ll work with the CPA that our clients are working with so that we get very granular. The last thing we want to do is make a suggestion and then wait until the first quarter of the next year and there’ll be a tax surprise for our clients. So we want to be transparent with whatever that tax liability is going to be.
Isaac Wright: Yeah, and I think also you all need to know this too. We have professional resources on the tax front that can help support and back up any of those recommendations.
But with all that being said today, Ricky, I think this is a great way for us to have that introduction to some of the basic concepts of financial or retirement planning. And by far for all of you on the program today, an IRA or your retirement plan, needs to be able to understand where money is going to be in the future when it comes to taxes. How are you going to utilize that for income? And how are you going to utilize that for your lifestyle and your approach to how you want to live?
So with all that being said today, Ricky, I want to thank everybody for being on the show today listening in. And until next month, we’ll talk soon.
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