Traditional versus Roth contributions: What to consider – PART 2

See Part 1 of this blog post here.[PR1] 

What’s best for me?

When determining which contribution is a better fit for you, understand that there is no single right answer for everyone.  The contribution that’s best for you will be determined by your personal situation.  Ask yourself the following 5 questions before making your decision:

  1. Do I qualify?  Retirement plans have thresholds you cannot exceed related to your income and how much you plan to contribute.  Annual limits for these plans, which in 2015 are $131,000 for single tax filers and $193,000 for married filers, were covered in a previous blog post.
  2. What is my current/future tax situation?  If you are in a high marginal tax bracket, say the 39.6 percent bracket, do you anticipate being in this tax bracket in retirement when you are not drawing a paycheck anymore?  If you expect your taxable income to drop dramatically in retirement, then you may benefit from making traditional contributions, thus receiving a tax deduction today, and deferring your tax obligation until you start withdrawing funds upon retirement when your may be at a lower rate.  If you are currently in a low tax bracket, the Roth is probably a better fit.  And if you are unsure, you can always do a little bit of both.
  3. What is my time horizon?  Traditional contributions made to a 401(k) or IRA can be withdrawn without penalty after age 59 ½, regardless of when contributions are made.  However, any Roth contributions must meet the 59 ½ year old rule AND a “5 year rule”, which means your first contribution needs to have been made more than 5 years prior to withdrawal in order for Roth earnings to be withdrawn tax-free.  This is why most people make a small Roth contribution at some point well before retirement in order to start that clock.
  4. May I need to withdraw the money early?  Unless you meet one of the few exceptions available in an IRA or 401(k), you will not be able to withdraw money from your plan before age 59 ½ without incurring taxes and penalties.  This is not the case with a Roth IRA.  A Roth IRA (NOT a Roth 401(k)) allows you to withdraw the contributions at any time penalty and tax-free, regardless of your age or how long the account has been open.  If you think you may need to withdraw money early, a Roth IRA is probably your best bet.
  5. What are my goals for the money?  401(k)’s and IRA’s are considered retirement plans, but some people use them for other goals too, such as for estate planning and charitable giving.  If you plan on keeping the money in these accounts past the age of 70, the government will require you to withdraw a set portion of the money each year.  This is called a Required Minimum Distribution (RMD).  However, the Roth IRA becomes a useful tool in this case too since it’s the only form of IRA or 401(k) not to have RMD’s.  This means your tax-free dollars can be passed on to the next generation of your family!  Consider your plan for the money when funding these accounts to maximize your tax deferred growth.

Overall, the decision of what type of contribution to elect for your retirement accounts will be an important one.  Make sure you are considering all factors before diving in.

If you have questions about what contributions are right for you, please feel free to email me, or please call the office number at (610) 895-8070 and we’ll be happy to discuss.

About Patrick Runyen

As a Wealth Manager at Independence Advisors, Patrick Runyen, CPA/PFS, CFP® works closely with clients to implement wealth management solutions. He leverages his technical financial planning and consulting experience to assist clients with investment counseling, retirement planning, estate planning, wealth enhancement, asset protection, tax planning, and other personally significant financial decisions. CLICK HERE TO ASK PAT.

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