Chocolate or vanilla? Coke or Pepsi? Cheeseburger happy meal or chicken nuggets, and so on. We Americans love choices.
With designated retirement accounts, we really have two tracks – the employer-platform track and the individual track. Most typically, these break down into the 401(k) and the IRA (Individual Retirement Account).
The two tracks: 401(k) and the IRA (Individual Retirement Account)
IRAs were created in 1974, the 401(k) in 1978, but we didn’t get options within them until the late Senator Roth spurred the creation of the Roth IRA, some 20+ years later in 1997. And the Roth 401(k) is the newest kid on the block, just available in 2006.
Traditional IRAs and 401(k)s are pre-tax – meaning that your contribution is made with current earnings that escape present income taxation, deferring those taxes until you withdraw the funds in retirement.
(If you withdraw funds before 59½ years old, you pay the tax plus a 10 percent tax penalty, unless you have separated from your employer at age 55 or older and withdraw the funds directly from a 401(k) – not an IRA.)
With the Roth versions, your contributions are made with after tax funds, where you pay the income taxes first and the net amount is invested. Although less goes in upfront, your original investment plus all of its earnings come out tax free.
Americans have gotten addicted to kicking the can down the road by paying taxes later – now is the BEST time since the Reagan years to pay taxes, because President Trump’s tax reform lowered rates and widened brackets.
Best time to pay taxes in decades
THAT IS HUGE – as the CBO reported in 2008 that tax rates will need to rise enormously as the Baby Boomers retire en masse, which really starts in 2022. And while Americans have gotten addicted to kicking the can down the road by paying taxes later – now is the BEST time since the Reagan years to pay taxes, because President Trump’s tax reform lowered rates and widened brackets.
The Roth has some special rules – like you cannot access growth tax free until you have had a Roth for at least five years and your 401(k) employer match, if you get one, will still go into the traditional 401(k).
There are also income limits on utilizing an IRA, although increased in 2019, but there are no income limits on a Roth 401(k) – so you cannot be income phased-out like you can with a Roth IRA.
And the Roth, because the tax has already been paid, eliminates the requirement of RMDs (required minimum distributions) at age 70½ - providing much more flexibility. And if you have already built your dollars in the traditional accounts, then a Roth conversion could be an excellent option – if it fits your circumstances.
And Roth IRAs eliminate the requirement of RMDs at 70½ - providing much more flexibility.
The bottom line is retirement strategy now goes well beyond just making contributions.
We must especially prepare for the tax consequences we’ll face once we are living off those funds in retirement and that means we should consider whether to leverage the beneficial Trump tax table now, or take our chances on where taxes are headed in the future, knowing the government has already told us that they must go up.
Rebecca Walser is a licensed tax attorney and certified financial planner and author of the book Wealth Unbroken, who specializes in the strategic planning of maximizing lifetime wealth while minimizing tax through her practice, Walser Wealth Management . She earned her juris doctor degree from the University of Florida and her Master of Law degree in taxation from New York University. She is a frequent national media contributor.