So far this year I have written posts on taxes and how the tax tables as withholding too little from most paychecks, for more information see 2018 & 2019 Income Taxes. Then last week I did a post on how to maximize your retirement accounts that can be seen at Maximize Retirement Accounts. And then this week we will combine the two to look at how to minimize your tax liability now while maximizing your retirement accounts in the future. To better understand these options visit a qualified financial planner.
When you think about retirement accounts, you generally consider the two types, those being ROTH and Traditional, now there are restrictions on who can contribute to IRA’s and there are even differences between the two types, which we will examine in depth a little later in the post. And we will also examine the effect of contributions to employer-sponsored plans and how much and what type of account you should contribute towards.
Now please note that the advice contained in this post in general in nature and is meant for your consideration only. This is not tax advice or financial planning advice that should be considered cart blanc but rather to stimulate your conversation that you should have with a qualified financial advisor. As I do not know your unique situation, it would be irresponsible for me not to make the disclaimer that the following is indeed generic and is not meant as actionable advice as I do not know your circumstances.
IRA’s
Now one popular way that people can save for their retirement is through the use of Individual Retirement Accounts or IRA’s. It is important to understand the two types of IRA’s and those are ROTH IRA’s in which you are able to make contributions that are taxed now, and all of the account’s gains are tax-free once you reach age 59 ½. When it comes to ROTH IRA’s, there are income limitations that you need to be aware of before making any contributions, and they are you must earn less than $193,000 for filers who are filing married joint returns and less than $122,000 for individuals you are free to contribute the maximum of $6,000. If you are over the age of 50, you are allowed to contribute an additional $1,000 for a $7,000 contribution in 2019.
If you decided that you would prefer to contribute to a Traditional IRA, the contributions limits are the same as the ROTH IRA, but there are some distinct difference between the two IRA’s. Provided you make less than $64,000 for single filers and $103,000 for married filing jointly you can take a tax deduction of your contributions which would lower your taxable income now, and you would then pay ordinary income tax on all your withdrawals in retirement. Also, with a Traditional IRA, you must begin making withdrawals at age 70 ½, at which point you may not continue to make contributions, those limits not imposed on ROTH IRA accounts. We will take a look at IRA’s and their tax implications when we also look at the tax effect of 401(k) contributions later in the post.
401(k)’s
Like IRA’s these retirement savings accounts come in Traditional and ROTH varieties. Unlike IRA’s there are no income restrictions on who can make contributions to these two account types. Like their IRA counterparts, they are either pre or post-tax contributions and are taxed or not in retirement depending on the account type. But unlike IRA’s that have relatively low contribution limits 401(k) participants can contribute up to $19,000 in 2019 for those under the age of 50. For those over the age of 50, they are allowed to make an additional $6,000 in contributions for a total of $25,000. Now, not all employers will offer ROTH 401(k)’s as the decision to offer both is up to each place of employment. And similar to IRA’s you must begin making withdrawals from a Traditional 401(k) at age 70 ½ unless you are still employed at the company with your 401(k) account and if you are still working you may also continue to make contributions after age 70 ½ as well.
Tax Implications
For those people who are in higher income tax brackets, you must also consider current and future tax implications on your contributions. For individuals who earn over $82,501 and married filing jointly earning $165,001, you will be in the 24% tax bracket in 2019. Now unless you will be in at least the 24% tax bracket in retirement, this is where I suggest you seek a qualified financial planner for more assistance and the following is a general view. I would recommend that you abandon the ROTH IRA and 401(k) at these incomes and take the tax advantages now at least when it comes to your 401(k) contributions. As for IRA’s, the Traditional IRA will not matter much as the income limits to deduct the contributions are at a much lower income. That leaves a non-deductible contribution, or a ROTH IRA I would elect for a ROTH IRA as the effect will only be a maximum of $7,000, and neither will affect your taxable income. And when it is between no tax advantage and tax-free later in retirement, I would elect for the tax-free later.
But when it comes to 401(k) plans the election of Traditional or ROTH can make a huge difference at the maximum levels as we are talking anywhere between $19,000 and $25,000 on your taxable income. At the 24% and high tax brackets, I would advise skipping the ROTH 401(k) and tax the tax benefits now on your higher taxed income and pay hopefully lower taxes once you do retire on these gains in the account. I recently did a 2018 tax return for some higher income earners who were in the 32% tax bracket and if you consider all of their 401(k) contributions being from that bucket of funds a maximum Traditional 401(k) contribution in 2019 would save you approximately $6,080 on $19,000 in contributions. This could cost you $2,850 if you withdrew the same $19,000 a year at 15% or an overall savings of $3,230. Double these amounts if you are married and both contribute the maximum to a 401(k) account.
It is up to each of us to plan what is best for our families, both now and in the future. This goes for your retirement accounts and the amount of taxes you are willing to pay either now and in retirement. While I am not discouraging anyone to not contributing to a retirement account of some kind, I am suggesting you do it in a tax efficient manner. And that means consider the tax benefits both now and what could be in the future and a financial advisor can assist you with that.
If you have any questions or comments, please feel free to contact me directly or leave a message here. And for a free PDF on financial planning sign up for my periodic email newsletter on the form below.
