Did you know that, “Thousands of companies have added Roth 401(k)s to their retirement plans, one of many new—and sometimes confusing—options designed to give workers more flexibility in retirement saving. Putting money into Roth 401(k)s could give savers more spending money, and lighter tax burdens, in old age.”
Traditionally, employers that offered a 401(k) only allowed for those funds to go in before taxes. That’s often a great thing in and of itself. With this we delay paying taxes today. The government allows us to keep the tax money we owe for now and it allows our money to often grow more quickly since there’s more working. Plus, it lowers our taxes today. If you’re over 50 you can put in up to $30,000 this year.
But let’s say you expect your taxes to be more when you’re retired. Why would you want to delay paying the taxes today to pay more later down the road? It’s a fair question. Have you seen our debt in America lately? It’s over $32.8 trillion. Don’t forget the government admits that by 2033 they’ll be able to pay 77 cents for every dollar of scheduled Social Security benefits. A cursory view indicates that taxes may go up.
To answer this dilemma many employers now allow for payroll contributions to go to a tax-free Roth 401(k). We pay the taxes today while rates are historically low and those funds are then immunized against further taxation. Ultimately, as the Wall Street Journal says, “Despite the complexity the Roth choice has introduced, it creates the opportunity for some to reduce lifetime tax bills and leave more money for retirement or heirs.”
The other advantage to Roth distributions in retirement is they may allow you to pay less taxes on your other taxable income in retirement. The distributions from the Roth account will not increase your taxable income.
Don’t forget that the tax cuts Congress enacted in 2017 will sunset at the end of 2025 if Congress does nothing to intervene. The point being that paying some of our tax today while rates are lower may be even more beneficial than waiting until 2026 when rates go back up.
The other cool aspect is that if you don’t use your Roth money your beneficiaries will thank you because inheriting your Roth money won’t cause their taxes to go up.
From the Journal article, “You want to leave your 401(k) to heirs. Since Roth 401(k)s will be exempt from the required distributions that traditional IRAs and 401(k)s are subject to, they can be passed on intact to heirs. Many nonspouse heirs who inherit Roth and traditional retirement accounts after 2019 must drain the accounts within 10 years of the owner’s death. That can push heirs of traditional IRAs or 401(k)s into higher tax brackets. But Roth heirs suffer no tax consequences.”
If you’ve wondered how to optimize your retirement account for taxation and you’d like guidance please let us know. We’d be happy to walk you through it. You can reach us at 864.641.7955.
Until next week,
David C. Treece,
Financial Planner
