With this year’s decrease in tax rates, it is time to
consider directing your retirement contributions into a Roth account.
Named for the Delaware Republican senator who proposed the creation of this type of account, a Roth retirement account is a vehicle for investing money that has already been taxed and which, when withdrawn for spending in retirement, is not taxed again. Nor, significantly, is the growth or interest on the invested money.
To illustrate, say I earn $100. After taxes I have $72 left and I put that into a Roth account. Years later, that initial investment is worth $300. I can take out that entire amount and not pay any more taxes on it.
In contrast, a non-Roth retirement account—including most
company-sponsored 401(k) plans—allows me to defer taxes and invest the entire
$100 upfront. Years later it might have
grown to $380; but when I withdraw it, the entire amount is taxable.
The theory behind non-Roth accounts is that in retirement
your income will be lower, thus your tax bracket and tax rate will be lower, so
you would presumably pay less in taxes by deferring the taxation until then.
But what if tax rates are higher when you retire, not lower?
That nullifies the “lower tax rate” argument. And having higher rates later is a distinct
possibility, especially when you look at the ballooning national debt and the
structure of the tax legislation that Congress passed. The tax relief is scheduled to expire after
just a few years. You could even say
Congress has scheduled a tax increase.
And that likely makes paying taxes today at the new, lower rates an even
better deal than delaying taxation until retirement.
As an additional benefit, Roth account money withdrawn in
retirement does not count toward total taxable income, which might keep you
under the threshold at which Social Security benefits become taxable, saving
you from paying taxes at all on that money.
See my post about taxation in retirement by clicking here.
So why would you not
put your retirement investment dollars into a Roth account? There are several reasons:
- Income restrictions: The limits are fairly high, but people beyond a certain income level are not eligible to contribute to a Roth account.
- Employer match: You are contributing all you can to your employer’s non-Roth 401(k) plan in order to get their “match” (the company’s contribution to your account) and you don’t want to miss out on the free money. And they don’t offer a 401(k) Roth option.
- Paying NO taxes: You believe that your total taxable income in retirement will be so low, or that you can structure it to be low enough, that you will not be taxed on your withdrawals, meaning you will never pay taxes—upfront or deferred—on the money invested.
- Tax law changes: You believe that the Roth account is such a good deal that eventually the government will get wise to it and change the law to allow taxation of the money in retirement or somehow reduce the tax benefit.
These are good reasons and not to be easily dismissed. (For example, I can’t imagine the government
ignoring for long the huge sums sitting in Roth accounts that they can’t touch
under current law.) Do the math for
yourself or hire a financial planner and go over your tax and retirement
strategies together. Then decide which
is better for you, Roth or non-Roth.
Until next time,
Roger
“There is a time for
everything, and a season for every activity under the heavens.” Ecclesiastes
3:1 NIV®*
*Scripture quotations taken from the Holy Bible, New
International Version® NIV®
Copyright © 1973, 1978, 1984, 2011 by Biblica, Inc.™
Used by permission.
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