EMILY FENG, HOST:
Tax Day just passed, so you don't have to think about your taxes for another year, right? Wrong. Our friends at Life Kit say you could be making better tax choices now that'll save you money the next Tax Day, like putting some money into a retirement account. Life Kit host Marielle Segarra walks us through how, what the two main types of retirement accounts are and why it doesn't matter that much which one you choose.
MARIELLE SEGARRA, BYLINE: Amanda Holden is a financial educator and author of the book "How To Be A Rich Old Lady." And she's constantly getting the question - what's better, a 401(k) or a Roth IRA? Her answer...
AMANDA HOLDEN: All retirement accounts are good.
SEGARRA: Retirement accounts are bank accounts that hold investments. And one reason everybody is always telling you to put money in them is that the stock market allows you to generate much higher returns than if you just put your savings in a bank account.
MARY CHILDS, BYLINE: And to kind of participate in broader economic growth.
SEGARRA: Here's former Planet Money cohost Mary Childs.
CHILDS: So as the economy around you is growing and more transactions are happening and businesses are growing, stocks are going to be going up, and you want to be a part of that. You don't want to get left behind.
SEGARRA: So that's a reason to invest in general. But the reason to put your retirement savings into one of these special retirement-specific accounts, that's all about taxes. Holden says you can think of retirement accounts as a kind of tax shelter for your investments, and there are two main types.
HOLDEN: Because of course, they had to make multiple different types of retirement accounts. It couldn't just be simple.
SEGARRA: On the one hand, you have your traditional accounts. That could be an IRA, a 401(k), a 403(b), something like that. With these, you take a certain amount of your income and shield it from taxes. Mark Gallegos is a CPA and partner at the accounting firm Porte Brown in Chicago. He gave me an example.
MARK GALLEGOS: Let's just say I decided to contribute $20,000 to my 401(k).
SEGARRA: Let's say his effective tax rate was 25%. Twenty-five percent savings on $20,000...
GALLEGOS: It would save you $5,000 in tax savings.
SEGARRA: So that's the cool thing, right?
GALLEGOS: In a way, you're using the government's money to help grow your retirement.
SEGARRA: Then you invest the money. It grows tax-free, and you pay taxes once you start making withdrawals in retirement. The thinking is you may very likely have a lower tax rate when you retire than you do now because your income will probably be lower.
OK, so on the other hand, you have Roth accounts. You'll recognize these because they all say Roth in the title - Roth IRA, Roth 401(k).
HOLDEN: Roth is the reverse. You are paying income taxes up front, but later on, you won't have to pay any income taxes when you pull the money out.
SEGARRA: Which means you'll never pay taxes on your investment profits. There are other differences between the two types of accounts, having to do with income limits and contribution limits and whether you're required to make withdrawals at a certain age. And Holden says which type of account you should prioritize right now depends in part on your current tax rate. But keep in mind, we can't tell the future. Tax law is always changing, and we don't know what rates will be when you retire. So she says...
HOLDEN: We can debate all day about whether Roth or traditional is better, but I think it obfuscates the point, which is that all retirement accounts are good because all of them allow you to grow your money tax-free.
SEGARRA: Other than that, Holden says, probably the best thing you can do is give yourself some tax diversification. Put money in both kinds of account. And most importantly, don't let confusion stop you from getting started. For NPR News, I'm Marielle Segarra.
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