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Roth or Traditional IRA? YES!

December 22, 2020

Should you have a ROTH or a Traditional IRA? The answer is not as straight forward as you might think. Unfortunately, it depends on your current situation, expectations in retirement, and your outlook on the political and economic future.

If you are in a high tax bracket now and expect to be in a lower tax bracket in retirement, then a traditional IRA may save you taxes in the future.

If you think you will be in a higher tax bracket, or that you expect taxes to go up in the future, then you should try to maximize your tax-free investments in the Roth.

While is might seem to make sense to choose one over the other, the fact is, it is often useful to have both. It is also useful to have a brokerage account with taxable investments. Not only can you take advantage of relatively lower long-term capital gains taxes, but upon your death, your beneficiaries can enjoy a step-up in basis. Another good thing is to pay for taxes for ROTH conversions with a taxable account, to maximize the amounts that can continue to grow tax free in the ROTH.

A good reason to establish a Roth IRA now is that it takes 5 years before you can withdraw investment gains in the account tax-free. So while you can actually remove contributions tax-free and without penalty from when you establish the account, you need to avoid touching the gains for that five-year period.

If you have a 401(k) or 403(b) with your employer, having both a Roth and traditional IRA can help provide investment diversification while preserving tax-deferred status, and providing a way to convert portions of your retirement into a Roth in the most tax efficient manner, The process we use is to examine your income for the year and what tax bracket you are in. From there we can determine how much you can convert into a Roth at your current tax bracket. Remember that IRAs and defined contribution plans are generally tax-deferred plans…so you have to pay taxes eventually. By partially converting to a Roth at the right times, you can minimize this tax burden and grow your tax-free bucket.

There are good reasons to build up a Tax-free bucket of funds in retirement. For one, distributions will not increase your taxable income in retirement. Added income from retirement accounts can have surprising effects in retirement, such as increasing the amount you need to pay for Medicare! More income can also require you to pay taxes on your social security benefits. These unintended tax traps can be mitigated with a financial plan that progressively converts retirement funds to a Roth.

If you would like to learn more, lets set up a time to talk!