On this episode of Ready for Retirement, James answers the question “Should I do a Roth or Traditional 401k?” James addresses this question by discussing, with practical examples and numbers, when it makes sense to use a Roth 401k, or IRA, and when it’s a better option to use a Traditional 401k, or IRA.
The general difference between the two is when you pay taxes, and whether your contribution is part of your taxable income. However, there are benefits to both options. With Roth accounts, you don’t have to worry about your tax brackets during retirement, since you’ve already paid taxes on that money.
Additionally, income from Roth accounts is not considered part of your provisional income, and therefore will not impact your Medicare costs or push you into a higher tax bracket. Finally, there is no required minimum distributions, so you are not required to take any income you don’t want or need.
In regard to Traditional investment accounts, you are able to save money in the present, as the money you invest is not taxed when you invest it, but later, when you withdraw the money. Therefore, you have less taxable income now. This can be very beneficial if you’re in a higher tax bracket.
With Traditional accounts, however, there are required minimum distributions, which means that you may be required to take income you don’t want or need, as well as be pushed into a higher tax bracket during retirement.
A helpful way to make this decision is by determining when you will be in a higher tax bracket, today or during retirement. You can answer this by considering your current income versus your retirement income, as well as the taxes in the state you live now as opposed to where you will live during retirement.
It’s also important to remember that we can’t know what taxes will be like between now and the time of your retirement. Finally, it’s helpful to keep in mind that you can shift money to Roth accounts after retirement if that’s best in your situation.
- Roth 401ks and IRAs
- You don’t have to be concerned with tax brackets in retirement
- Roth funds are not considered part of your provisional income
- Income from Roth accounts will not impact your Medicare costs or surcharges
- Roth 401ks or IRAs are not subject to required minimum distributions
- You are not required to take out income that you don’t want or need
- Any income you take will push you into a higher tax bracket
- Future generations don’t have to pay taxes on income from these accounts
- Traditional 401ks and IRAs
- You can save money if you’re in a higher tax bracket before retirement
- It is possible to start shifting money to Roth accounts once you retire
- There are required minimum distributions that can push you into a higher tax bracket during retirement
- Future generations do have to pay taxes on these accounts, and the income may push them into a higher tax bracket
- Circumstances that result in a higher tax currently versus during retirement
- Your current income
- Where you live now and where you will live during retirement
- The tax legislation
0:08 – Should I do a Roth or Traditional 401k?
1:07 – A real life example of how the two options play out
3:49 – Roth 401ks and IRAs
10:40 – Traditional 401ks and IRAs
14:10 – Shifting money to Roth accounts
15:32 – Summary of how to decide which is best for you