Whether with traditional savings or Roth IRA, saving for retirement is one of the most important financial goals that a person can have. It is a very long-term goal, but it is one that makes a huge difference in terms of financial stability, ability to retire, and quality of life in retirement. While it might seem like a long way off, this is an essential goal to start working on as early as possible. Starting early is a key part of accumulating enough savings to retire comfortably.
There are several different strategies to help you reach your retirement goals, and it is a good idea to use them in concert with each other to tap into as many different strategies as possible and use all the different available resources as tools. In this post, we will discuss and compare traditional savings and a Roth IRA account.
The End Goal of Retirement Savings
The goal of retirement savings is to put away a consistent amount of money and allow it to grow over time. The government provides different incentives, programs, and tools to help people accomplish as much as they can and get as much out of their savings as possible. One important resource is Social Security benefits. Upon reaching an old enough age, everyone is entitled to a monthly amount of cash for the rest of their life.
The amount depends on how long you worked, how much you earned, and at what age you start to collect benefits. For most people, Social Security will make up a major source of income in retirement, but it will not be enough to fully pay for all bills, expenses, and spending. That means other forms of savings need to make up the gap.
Traditional Savings
A traditional savings account is just an account at a bank where you store money. You receive an interest rate that causes your savings to grow on their own, and you can also contribute to the money out of your earnings. It is possible to set up regular deposits that will happen automatically on a certain day of the month, which can help take the pressure off remembering to do this on your own and make it a smoother process.
The pros of a traditional savings account include the fact that the money is insured by the FDIC up to $250,000 per account, so you don’t have to worry about losing everything. You also have the simplicity and convenience of the money just staying at your bank. The major downside of the traditional savings account is that they have very low-interest rates.
While there have been times in history when a savings account might have had a high yield, most of the time, including now, it is hard to find an account that can even keep up with inflation. So while they are safe, a savings account has a lot of trouble providing a significant amount of growth. It is that growth that makes retirement savings add up to something big by retirement age, so this is a very important downside.
The Roth IRA
A Roth IRA is a special kind of investment account that is defined by the government. It has several important properties. First of all, as an investment account, it works differently from a savings account. In an IRA, you add money to the account and use that money to buy stocks, bonds, and other investments.
Usually, you don’t have to do all of this manually– you will pick one or more choices for investments at the beginning, and the money that you add will automatically go towards buying more units of those investments. Most people pick mutual funds or other types of investment that include a broad and diversified set of assets in their portfolio. So far, this is similar to a brokerage account.
Understanding the Tax Advantage
What really sets the Roth IRA account apart is the tax advantage. Normally, investment savings are taxed twice. First, the money is taxed when you earn it as income– you pay federal income taxes on it before investing it. Then, the money is taxed again once you sell off your investments and withdraw the money to use for retirement spending. In a Roth IRA, the distributions that you take at the end are not taxed, so you do not have to worry about paying out a chunk of your savings into a tax bill. This is a big advantage for Roth IRAs.
With the right investments, a Roth IRA will have a much better rate of return than a traditional savings account. However, these investments involve risk, and it is possible to lose money instead of gaining it. Over time, compound interest will play to your favor and allow money to grow. You can use a compound interest calculator to forecast where your money will wind up.
Open Your Roth IRA
Everyone has access to opening their own Roth IRA, although there are annual limits to how much you can contribute. It is entirely possible to use both a savings account and a Roth IRA at the same time. For example, you could save money in the Roth until you hit the max for the year, then put the rest into a traditional savings account until the limit resets the next year. Or you could focus your retirement savings in the Roth IRA and use the traditional savings account for something else, like an emergency fund or savings for a down payment.
There is no perfect strategy for saving for retirement, and different people will make different decisions about which tools to use and how many of them to use. What is important is starting as early as possible and making sure that you stay consistent with your savings. Compound interest is very powerful, but it takes a long time to fully take effect. Without years and years of saving and investing, there will not be enough accumulated interest to make the money really grow, and that is what it takes to save enough to make for a retirement that meets all of your needs and maintains a balance long enough to keep your budget in good health.