Planning for retirement and other taxing decisions

While reading a list of business headlines, the following captured my interest: "I am 52 years old planning for retirement. Should I open a Roth IRA or open an index fund or exchange-traded fund?" This implied they were the same thing. They are not.

An IRA (individual retirement account) is an account designed to help people save for retirement. IRAs are of two types: traditional or Roth (named for the congressman who created the legislation).

A traditional IRA lets you save for retirement with dollars that have not been taxed. If you put $5,000 into your traditional IRA, your income for the year contributed is reduced by $5,000 for that tax year. You are taxed on your traditional IRA when you take out the money plus any growth it experienced.

With a Roth IRA, you save with dollars already taxed; there is no income reduction for your contribution. The advantage to a Roth is when you take out the money, plus the growth, you pay no income tax on it.

In 2023, the annual contribution limit to either IRA is $6,500 for those aged 49 or younger. For ages 50 or older, the limit is $7,500. You can open an IRA or contribute to an existing one up until the day of your tax filing.

There are rules for who can open an IRA. First, you must have earned income. Second, if you have a retirement plan there are limits based on what your income is. These limits are different if you are filing jointly or by yourself. If you make over the limits, you will not be able to open an IRA this year. I am not a tax adviser and recommend you go over the rules and limits with your tax adviser.

An index fund is a mutual fund or exchange-traded fund designed to follow certain preset rules so that it can replicate the performance of a specified basket of underlying investments. In simple terms, index funds are a popular choice for investors seeking a low-cost, diversified, and passive investment strategy. They are designed to replicate the performance of financial market indexes, like the S&P 500, and are ideal for long-term investing, such as in retirement accounts. All mutual funds from a tax standpoint are treated the same. Money that goes into the fund is with untaxed dollars.

Taxes are owed when the money is taken out if it exceeds what was put in. The exception is when the mutual fund pays a dividend or capital gain. Then you are taxed in the year the dividend or capital gain was paid.

An exchange-traded fund (ETF) is a type of pooled investment security that operates much like a mutual fund. Typically, ETFs track or seek to outperform a particular index, sector, commodity, or other asset.

So if you are planning for retirement, you can open a Roth IRA or a traditional IRA. The only difference is tax treatment. If you open a Roth or traditional IRA, you will need to choose how the money is invested. You can invest in fixed assets or securities (stocks or bonds). An index fund or ETF are securities. If you are not eligible for a Roth or traditional IRA, then you can open a mutual fund or ETFs to help with retirement. It is not a one or the other choice.

Reach out to a professional for both tax and investment advice.