October 2021 Question Of The Month

By Admin Prepare

October 5, 2021

“Hello. There has been a lot of talk and press about the benefits of saving in a Roth IRA. However, for my case, I am just not seeing it. My husband and I make a good living and are in a higher tax bracket than we will be in at retirement. So, wouldn’t it be best for us to save in a traditional IRA and 401(k), take the tax deduction now, and pay taxes later when our taxes are lower in retirement? Thank you.” Melissa

Hi, Melissa. Your question is a very good one and is on a topic that everyone must make the proper decisions about in order to maximize their retirement plan. As you probably have heard me say several times – saving for retirement is very important, but how you save is more important. What I mean by that is in order for your retirement savings to be worth as much as possible, you have to save in the right types of accounts for your specific situation.

Now, your reasoning in your question is correct. If you are in a higher tax bracket now than you will be in retirement, then you should take the tax deduction now and pay taxes later. Remember, the ultimate retirement goal is to pay the least amount of taxes on your retirement account money as possible. Thus, again, if you can save more taxes now than you will pay later, then saving in a traditional IRA or 401(k) is the proper way for you to go.

However, the problem for many people is they actually will not be in a lower tax bracket in retirement, and they are saving incorrectly which will cost them a lot more in taxes. Why is that the case? Well, there are several reasons.

The main reason is how the tax system works in retirement. When you take money out of a traditional retirement savings plan, that money, of course, is taxable at that time. However, that money also counts in the provisional income formula which determines how much your Social Security is taxed. Thus, in most cases, traditional retirement savings withdrawals cause Social Security to be taxed. In addition to this, that income also gets calculated into the formula which determines how much your Medicare part B premium costs. Also, this income can cause taxation on dividends and capital gains.

So, not only is that money taxable, but it can cause other taxes as well, and most people are not aware of this or do not consider these things when saving for retirement. Roth income is not taxable in retirement and also is not counted in these formulas.

Next, you have to consider inheritance and estate taxes. Again, traditional retirement savings income is taxable to the people who inherit your money. Normally, for married couples, one person passes away before the other which causes the surviving spouse to have to file as a single person, which is an immediate tax increase in most cases. And since you lose one of the Social Security checks when a spouse passes away, the surviving spouse may very well need more income from the retirement savings, which, again, is taxable now at higher single rates.

Next, you have to consider the many deductions you may lose in retirement. During your working years, many people are able to deduct mortgage interest and charitable contributions, which saves tax dollars. In addition, you get tax credits for children. In retirement, these deductions usually go away.

And finally, you also have to give some serious consideration to where tax rates will be in the future. Today’s tax rates are near historic lows, but that will probably be changing here very soon based on overspending and national debt issues. So, you may very well be in a higher tax bracket now than you will be in retirement at today’s tax rates, but that may very well not be the case in the future.

So, as you can see, there are many things you have to think about and consider when determining how to properly save for retirement in order to minimize your overall taxes in retirement. Many people are shocked and surprised that they actually have to pay more in taxes in retirement based on all of the factors above. Again, if you are absolutely sure you are in a higher bracket now than you will be in retirement, then you are saving correctly. But do yourself a favor and factor in all of the above information to make sure you still feel that will be the case.

To learn more and get your retirement planning questions answered, visit the Prepare Institute website (www.theprepareinstitute.org) to find a retirement course or class near you.
Content is for educational and informational purposes only. It is not intended to be used as the sole basis for financial decisions, nor should it be construed as advice designed to meet the particular needs of an individual’s situation. You should contact your retirement and tax professional before utilizing any of the information in this article.