When working with clients to help them determine a retirement savings strategy, a common question is whether to contribute on a pre-tax basis, like in Traditional IRAs or 401(k)s, or an after-tax Roth basis to Roth IRAs or Roth 401(k)s. This choice can significantly impact your financial future. Today, I will shed light on some of the key considerations to help you make an informed choice. As I begin, remember to check with your income tax professional to get their opinion based on your unique circumstances.
The first thing to keep in mind is when you will incur income tax on your savings. Opting for a pre-tax retirement account is beneficial if you anticipate being in a higher income tax bracket today than during retirement. By reducing your taxable income now, you defer paying taxes until withdrawal in retirement. In contrast, Roth contributions are preferable if you are in a more favorable tax situation today. While you do not get to deduct your contributions up front, both contributions and earnings grow tax-free, providing tax-free withdrawals in retirement. It is important to note that there are certain rules that must be followed here, so be sure to check with your financial advisor or accountant.
Secondly, remember that retirement does not necessarily simplify your tax situation, especially for retirees collecting Social Security and/or Medicare benefits. Federal income tax regulations include “tax torpedoes” for retirees, triggering significant changes in tax liability and future Medicare costs once certain income thresholds are crossed. Pre-tax retirement accounts, with their Required Minimum Distributions (RMDs), can have a significant impact on your tax situation and future Medicare premiums in retirement. In contrast, qualified Roth IRA withdrawals in retirement are federal income tax-free!
Finally, it is helpful to consider your heirs. The decision between pre-tax and Roth savings extends beyond your lifetime, affecting the tax treatment of inherited accounts. Beneficiaries of Traditional IRAs inherit tax obligations, as they will owe income tax on withdrawals. However, Roth IRA beneficiaries inherit the money in the accounts free of income tax!
In summary, when deciding between pre-tax and Roth retirement savings, it is crucial to weigh your current and anticipated future tax situation, navigate the complexities of retirement tax laws, and consider the implications for your heirs. The Master’s team, in coordination with your income tax professional, can help tailor your retirement strategy to maximize tax efficiency in light of what is most important to you. Please do not hesitate to reach out to us!
Master’s Wealth Management Inc. is a registered investment advisor. The content herein is for informational and educational purposes only and is not intended to be investment advice. Investment advice is provided on an individual basis only after obtaining all details regarding the client’s situation. Information herein is at a point in time and subject to change. This information is general in nature and should not be considered tax advice. Investors should consult with a qualified tax consultant as to their particular situation.
