One of the most common questions that comes up in my conversations with clients about saving for retirement is whether to use traditional pre-tax contributions or Roth contributions to retirement accounts such as 401(k)s and IRAs. Assuming you are eligible for and have access to both, the answer is almost always a balance of each.
Most people end up being in a lower tax bracket when they retire. That means using pre-tax contributions while you’re working saves you more in taxes now than you’ll pay later when you take the money back out. But that doesn’t mean you should have all of your retirement money in pre-tax accounts. There are many reasons to also make Roth 401(k) or IRA contributions.
First, tax rates change frequently. Over the last 50 years, we’ve seen Congress pass significant tax rate changes.
Second, having money in multiple buckets allows you to have more control over your taxes each year by deciding where to take money from when making withdrawals. What if you want to pay cash for a new car or pay down a mortgage balance? A large traditional IRA withdrawal could push you into a higher bracket.
Finally, those who hope to pass assets down to heirs may want a different mix. There’s a pretty good chance that someone’s heirs will still be working when they receive an inheritance, meaning they will be in a higher tax bracket already themselves.
Things like pensions, part-time earnings, retirement age, Social Security benefits, relocation, and expected inheritances of your own can significantly change the optimal mix. We take variables like these into account with our clients as we walk through our proprietary VP360 planning process.
Financial Advisor