Should You Defer Income Taxes?
Should you pay income taxes now so you can withdraw funds after retirement tax free? Or are you better off delaying income taxes until after retirement? This is a basic decision when choosing between a traditional deductible individual retirement account (IRA) and a Roth IRA, or between a 401(k) and a Roth 401(k) plan. With the Roth options, you are paying taxes now so you can take qualified distributions income-tax free. With the traditional IRA and 401(k) plan, you are delaying taxes until distributions are taken. The standard advice is to consider whether your tax bracket will be higher or lower in retirement. If you are likely to be in a higher tax bracket, you’ll usually benefit from the Roth options, because you will be paying taxes at a lower rate now. If you’re likely to be in a lower tax bracket, you may benefit more from a traditional IRA and 401(k) plan, because you’ll pay taxes at a lower rate after retirement. Most people naturally assume their tax rate will be lower in retirement since their income will typically be lower. That assumes income tax rates will stay constant over that time period, even though they are at historically low levels. No one knows how those rates will be adjusted by Congress over the years. However, many believe that income tax rates have nowhere to go but up. Thus, it may be prudent to use tax diversification for your portfolio. This strategy attempts to protect your portfolio against tax rate fluctuations. It is a concept similar to asset allocation in which you protect your portfolio against price fluctuations. With tax diversification, you invest in a number of investment vehicles with different tax ramifications. For instance, you might invest in a Roth IRA, from which qualified distributions can be taken with no tax consequences; a 401(k) plan, saving you taxes now and paying ordinary income taxes on qualified distributions; and taxable accounts, where the capital gains taxes must be paid on sales of appreciated investments. During retirement, you can then monitor your tax situation and withdraw money from assets that make the most sense in any particular year.
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This newsletter was prepared by Integrated Concepts Group, Inc. The opinions expressed in this newsletter are for general information only and are not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. The views expressed are those of the author and may not necessarily reflect those held by PlanMember Securities Corporation. Material presented is believed to be from a reliable sources and PSEC makes no representation as to it accuracy or completeness.