For most people who fall into one of the top income tax brackets, odds are good that you will stay there after you retire. Some of these retirees even move up a bracket! If you earn a more generous income, you’re obviously able to save more for retirement.
But for those who accumulate a significant nest egg, there is a potential downside. If you’re investing in certain tax-advantaged accounts like a 401k, you’re enjoying a terrific income tax benefit now. Those contributions aren’t taxed… But when you retire and begin taking distributions from your account, the IRS will want to collect their share. Therefore, if you fall into a higher income tax bracket in retirement, you can expect a hefty tax bill each spring.
One way around this dilemma is to save some money in another type of account, which allows for tax-free distributions once you retire. A Roth IRA performs this exact service to you.
Contributions to Roth IRAs are taken from income that is already taxed. The money in the account grows with taxes deferred each year, and your qualified distributions (once you retire and begin taking them) won’t be taxed either.
If you have already opened and funded a traditional IRA, rolling all or part of the money into a Roth IRA is sometimes a smart plan. This is an especially important consideration if you plan to keep working longer than the average retirement age, or if you otherwise don’t need to take distributions from the account just yet. Roth IRAs don’t require minimum distributions by age 70 ½, like most other retirement accounts do, so your money can continue to grow longer.
As with any retirement planning option, there are benefits and drawbacks to Roth IRAs. Don’t rush out and open one just yet! The point we’re making is that you have many options at your disposal, and you should carefully weigh the risks and benefits of each one as you continue on your path toward retirement. For more information on planning for retirement income, and the eventual income taxes that you might face, give us a call. We can help you put together a retirement strategy that works for your situation.
Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.