Most people think about their retirement but not everyone plans for it. They believe everything will be fine if they sign up for their employer’s 401(k) – or that they will have enough to retire through Social Security alone. Some workers might do just fine with their employer’s retirement or pension plan and Social Security checks during retirement. However relying exclusively on automatic participation in these types of plans will not always earn retirees enough money – and it could cost them a lot of investment earnings when tax time rolls around.
Income Tax Rates Career Length and Social Security Withdrawal
Depending on one’s career length and when an individual takes Social Security payments weighing the benefits of a tax-deferred retirement account versus one with tax-free earnings can determine which account is right for an individual.
If an individual wants to work past 70½ years old when distributions are required the total projected income must be estimated. Working past required distribution age can put a taxpayer into a different tax bracket especially when taking into account that not all Social Security benefits are tax exempt. Tax-free growth accounts such as a Roth IRA or Roth 401(k) may be more advantageous for individuals who expect to work past the traditional retirement age of 65 – versus a traditional 401(k) or IRA that provides savers with immediate tax savings.
Long-Term Tax Forecast
If some experts are right and the $17 trillion (and growing) national debt needs to be reined in federal income tax and capital gains taxes could very well be raised in the near future. Individuals with tax-free investment accounts enjoy the obvious benefit of being insulated from any future tax increases – this in comparison to traditional IRA and 401(k) accounts that will be taxed at the present (and likely higher) income tax rates.
Dividend Intensive Investments
If a retiree has a lot of investments that produce dividends and are reinvested tax-deferred growth accounts might be a better deal depending on the individual’s career length. For example if an investor is looking to grow his or her retirement savings focusing primarily on dividends along with an increase in stock price a tax-deferred account might be advantageous.
One example would be investing $10000 in an exchange trade fund or mutual fund that pays $500 in dividends. Along with taking advantage of the reinvestment there would be an additional reinvestment of the money that would have gone to taxes but would instead go back into the mutual fund or ETF.
Over decades the compounding would be far more impactful from a tax deferred account especially when distributions would only be required at age 70½ instead of when the mutual fund or stock is sold and taxed at long- or short-term tax rates.
Depending on a retiree’s current tax rate projected career length and retirement objectives a tax-deferred or a tax-free growth retirement savings account is usually a better choice. As with all financial matters it’s best to consult a professional advisor for guidance.