No one exactly looks forward to paying taxes, particularly income taxes. So, you might wonder why anyone would essentially pay their income taxes years ahead of retirement… And yet, that’s what many soon-to-be retirees have chosen to do. Why?
Retirement planning involves a web of decisions, but you will face two basic choices with regard to your savings: Should you set aside pre-tax dollars in a qualified retirement account (like a 401k), and then pay taxes on that money as you take withdrawals in retirement? Or, should you set aside after-tax dollars now, in a Roth account, and enjoy tax-free income from distributions once you retire?
You might wonder why this matters. You’re paying taxes either way, so what difference does timing make?
It comes down to tax brackets. Depending upon your tax bracket now, versus your tax bracket in retirement, you might actually pay a different percentage of your income in taxes. So, for those who will drop down to a lower tax bracket in retirement, a qualified retirement account makes sense. But for others, particularly those who will remain in the same bracket or even move up, a Roth account offers the better deal. Some people even choose a combination of both savings vehicles.
For those with higher incomes, a Roth 401(k) often makes more sense than a traditional 401(k) or even a Roth IRA, for these reasons:
- You aren’t subject to an income limit, in order to make contributions (Roth IRAs phase out contributions at higher income levels)
- The growth on your funds will not be taxed
- When you retire or leave your employer, you can roll the Roth 401(k) into a Roth IRA, if you choose, and enjoy additional benefits
- If you choose to roll over to a Roth IRA, minimum distributions at age 70 are not required, so you might be able to further diversify your retirement income or leave a legacy to your heirs
Give us a call if you would like to learn more about Roth 401(k) accounts, or if you have any other retirement planning questions. We can help you weigh your options, and decide upon the most tax-advantaged way to save for retirement.