There has been a lot of talk about Roth conversions so I wanted to help…
While it’s hard to say what the tax laws will be in 30 or 40 years, it is likely that distributions from different types of retirement accounts will still receive special tax treatment. In addition to ensuring the investments in your retirement nest egg are well diversified, you should also consider diversifying your retirement account types.
We want to highlight three types of accounts: (1) Traditional IRA/401k’s, (2) Roth IRA/401k’s and (3) Taxable investment accounts. For those not familiar with these types of accounts the following is a brief summary:
Traditional IRA/401k’s are funded with pretax dollars (these dollars have not yet been taxed meaning that you reduce your taxable income when you contribute the funds) and are taxable (they increase your taxable income) when you take the funds out.
Roth IRA/401k’s are funded with after-tax dollars (these dollars have been taxed so there is no reduction of taxable income when you contribute) and are tax free when you withdraw those funds in retirement. Both traditional and Roth retirement accounts grow tax free so you are do not pay taxes on income and gains while the funds are in the account.
Taxable investment accounts receive no favorable tax treatment for contributions, gains and income but have no tax impact to you when funds are distributed (unless gains are realized when liquidating investments to make the distribution).
If your retirement is well planned you have an idea of how much money you will need to maintain your lifestyle. Retirement income will come from social security and pensions with the remainder made up of distributions from the previously mentioned accounts. But if all your assets are saved in traditional retirement accounts the distributions from those traditional IRA/401k funds will increase your taxable income. Balancing withdraws between these account types can reduce your tax bill but requires the flexibility of having assets in traditional, Roth and taxable brokerage accounts.
What mix of savings is right for you? That depends on your personal situation. As an example, someone in a lower tax bracket today who may be in a higher bracket in the future might want to focus on funding the Roth category of accounts first. Someone that believes they will be in a high bracket in retirement regardless of distributions might want to focus on the traditional. Regardless of your personal situation there are good reasons to balance your retirement savings among the different categories of accounts. To get a customized plan for your situation consider meeting with an independent, fee-only® and credentialed advisor.