Many Retirement Savers Would Be Better Off with Roth

You need to determine where you are in the progressive marginal tax system. There are three tax saving items that can lower your tax bill: exemptions, deductions and tax credits. (But your income will determine whether you are able to take advantage of these items.) Once you’ve determined your tax bracket you can weigh the restrictions of your 401k against the tax savings of your contributions. Many middle class Americans are paying a blended tax rate of 18%. A $1,000 contribution saves $180 and over 30 years that tax savings totals $5,400. But when you take a distribution from your 401K, you pay ordinary income taxes on the distributions and those distributions figure in the calculation on the taxes you’ll pay on your Social Security benefits.

Roth IRAs should be the top consideration for most Americans who invest in mutual funds, ETFs and annuities for retirement. For most of the middle class the tax deduction of a 401k plan doesn’t generate a significant economic benefit during your working years and dramatically increases ordinary income taxes during your retirement. There are two exceptions to using Roth IRAs instead of your 401k plan: If you are paying a very high effective tax rate and you’ve confirmed your retirement tax rate will be less; or your employer matches some part of your contribution.

Roth IRAs are not tax deductible, but accumulate tax deferred, and are distributed tax-free. Roth IRAs do not have a mandatory minimum distribution like 401k plans, and are not includable for the provisional income test for Social Security benefit taxation. This is another example of tax diversification. Some taxable income during retirement can be offset with exemptions and deductions. Some tax-deferred income can delay income into the future to delay taxes. Keep in mind that non-qualified tax deferred products like annuities return your original principal (basis) tax-free and could come in handy in tax planning during retirement. Tax-free income generated from reverse mortgages, HSA accounts and cash value life insurance are not includible in the provisional income test for Social Security taxation under current law.

Using a Roth IRA today could payoff big tomorrow and let you keep more of your money in retirement.