If you’re in a high tax bracket now and expect to remain in a high tax bracket after retirement, should you prioritize pre-tax retirement accounts or Roth retirement accounts for individuals?
James answers this and discusses various factors to consider in making this decision, including current and future tax brackets, required minimum distributions (RMDs), charitable giving, life expectancy, and the impact on heirs. Using a real-life scenario, James offers a thoughtful approach to help you make an informed decision based on your unique circumstances.
Questions answered:
Should individuals in high current tax brackets prioritize pre-tax retirement accounts or Roth retirement accounts?
What impact will required minimum distributions (RMDs) have on your future tax situation?
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⏱Timestamps:⏱
0:00 Intro
3:48 Considering Roth contributions
7:05 Example
13:25 Charitable giving
15:42 Life expectancy
18:18 What about your heirs?
20:52 Outro
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Pretax vs Roth- Which is Better for You If You’re in the 24% Tax Bracket?
When it comes to planning for retirement, one of the most important decisions you’ll have to make is whether to invest in a pretax or Roth retirement account. Both options come with their own set of advantages and disadvantages, and the right choice for you will depend on your individual financial situation and tax bracket. If you find yourself in the 24% tax bracket, it’s important to understand the implications of each option to determine which is better for you.
Pretax retirement accounts, such as traditional 401(k) and traditional IRA, allow you to contribute money before taxes are taken out of your paycheck. This means that the contributions are tax-deductible, lowering your taxable income for the year in which you make the contributions. This can provide immediate tax savings, especially if you are in a higher tax bracket. However, when you withdraw the money in retirement, it will be subject to income taxes at your ordinary tax rate at that time.
On the other hand, Roth retirement accounts, such as Roth 401(k) and Roth IRA, are funded with after-tax dollars, meaning you don’t get a tax deduction when you make contributions. However, the biggest advantage of a Roth account is that your withdrawals in retirement are tax-free, including any investment gains. This can provide significant tax savings in retirement, especially if you anticipate being in a higher tax bracket in the future.
So which option is best for someone in the 24% tax bracket? It ultimately depends on your individual circumstances and financial goals. Here are a few factors to consider when making the decision:
1. Current vs. Future Tax Rates: If you believe that your tax rate will be lower in retirement, a pretax account may be the better option, as you’ll get the immediate tax savings now and pay taxes at a lower rate later. However, if you expect your tax rate to be the same or higher in retirement, a Roth account may be more advantageous.
2. Income Needs in Retirement: Consider how much income you will need in retirement. If you anticipate needing a higher income to maintain your lifestyle, a Roth account may be more beneficial, as tax-free withdrawals can provide more spending power in retirement.
3. Estate Planning: If you want to leave an inheritance to your heirs, a Roth account may be a better option, as the tax-free withdrawals can provide a larger inheritance compared to a pretax account, where withdrawals are subject to income taxes.
It’s important to note that you don’t have to choose just one type of account. Many people choose to diversify their retirement savings by contributing to both pretax and Roth accounts to hedge against future tax changes and to provide more flexibility in retirement.
Ultimately, the decision between a pretax and Roth account should be based on your individual financial situation and long-term goals. If you’re unsure which option is best for you, consider speaking with a financial advisor who can help you create a retirement savings strategy that aligns with your needs and objectives.
You can ONLY put soo much money into a Roth each year!
She's focusing too much on tax brackets when things are going to be more complex than that. Will they save more if they file jointly or separately? His RMD divisor should be 11.67 at age 73, which means, his RMD is the sum of whatever he has in his IRA compatible accounts divided by 11.67. For every $100,000, he will be required to take $8,568. What if he converts $25,000 per year from an IRA compatible account to a Roth compatible account starting in 2025 for the next 8 years? His RMD taxable gross would be reduced by $17,136 and 25% of that would be a tax savings of $4,284 per year (very rough estimate) starting at age 73. Is that savings worth the effort?
Too much nothing in the beginning.
I really liked this video. It made me think a lot about saving money for when I'm older.
THANK YOU! I had no idea about the charitable giving! I would rather give money to something we care about than have the RMD pushed on us when we do not need the funds. EXCELLENT POINTS!!!!!
Including some specific numbers on inheritance tax would be helpful. I know you have to include a caveat because the numbers might change etc. But at least we can have some idea of whether or not we should be concerned. For example, most of us don't have to worry about our heirs being subject to inheritance tax because the federal limits are pretty high and in my case in the state of New Jersey they have been eliminated. You may also point out that there are two kinds of taxes that your heirs might face, the inheritance tax and the estate tax. I realize it's difficult to simplify a very complicated subject. Thanks for doing the podcast.
I was born in 1957, when do my RMD's kick in?
One point you didn't really emphasise is that your contributions are made at your marginal tax rate but your withdrawals are at your effective tax rate. So even if your withdrawals put you in the same marginal tax rate bracket, your effective rate is still lower.
Love it
I am retired and in the 24% tax bracket. I am still putting money in the ROTH
Pre-tax is always the best answer for any tax bracket as long as you invest the current-year tax savings in a Roth IRA or taxable brokerage account.
Almost all of these commentaries disregard the tremendous benefit of compound growth on the up front tax savings.
Then make a Roth conversion plan approaching and during retirement. Balance with comprehensive tax and income strategy that accounts for pensions, SS strategy and RMDs.
The thing about Qualified donations (13:29) is that you had to pay social security taxes when you earned this deferred salary, which could have been 20 years ago, which complicates the cost/benefit of this option.