Is it a good idea to have a Roth and traditional 401k when heading into retirement?
It's hard to deny that having balance in your life is a good thing. A balanced diet is the foundation to eating more nutritiously. Workers with a strong work-life balance tend to be both happier and more productive on the job. Having a balanced w...
It's hard to deny that having balance in your life is a good thing.
A balanced diet is the foundation to eating more nutritiously. Workers with a strong work-life balance tend to be both happier and more productive on the job. Having a balanced workout routine at the gym better ensures your entire body is being toned. But is balance also a good thing when it comes to saving for retirement?
It's a great question, and it's a question we recently received on our radio program: "Is it good advice to have both a Roth and a traditional 401k going into retirement?"
We love the idea of putting money into both the tax-deferred and the tax-advantaged options of your 401(k). Even though it can be tempting to want to put all of your retirement savings into the tax-deferred option in order to take advantage of the instant tax savings, a more balanced approach is likely to be the better option.
When we work with our clients, we break down their assets based on their tax treatment-immediately taxable, tax-deferred or tax-advantaged. We believe the best strategy is to have a blend of all three buckets to provide the greatest number of available planning strategies. If you simply opt to defer the tax on all of your savings today, it becomes challenging to fill up your other tax buckets in an equitable manner.
The end result from solely contributing to the tax-deferred option a massive IOU to the IRS, and every distribution you make in retirement is going to carry a tax hit. This means that, depending on your tax bracket, you may need to withdraw 20-40 percent over the amount you actually needed in order to pay the tax from the distribution. For instance, someone in the 25 percent tax bracket who needs $20,000 would actually have to withdraw $25,000-and that's just accounting for federal taxes.
Plus, that tax-deferred money will be subject to required minimum distributions (RMDs) beginning at age 70½, meaning you'll have to take distributions from your traditional 401(k) every year, even if you don't need the money. Having a massive allocation of tax-deferred dollars could mean your income, and subsequently, your tax bracket, could rise dramatically.
Not only will you have to pay a tax on all of your retirement distributions, you also have no idea what that future tax rate may be. It's possible you may be in a lower tax bracket, but that is by no means a given.
There will be times during your retirement where the best place to dip into your savings is from your taxable account. There will be other moments when you have lower income levels and you'll benefit from realizing the taxes on your tax-deferred savings. And of course, there will be periods where you'll be thankful you have some tax-advantaged money in a Roth. Being balanced with your savings during your working years will help you be ready for all of these different moments and have a smart place to take monies from when considering tax consequences precisely where you need them.
By Bruce Helmer and Peg Webb are financial advisers at Wealth Enhancement Group and co-hosts of "Your Money" on KLKS 100.1 FM on Sunday mornings. Email Bruce and Peg at firstname.lastname@example.org .