One of the most impactful items you can review each year is your retirement account contributions. For 2023, the contribution limit significantly jumped to 22,500 for workers under age 50 and $30,000 for those 50 and above.
Of equal importance to deciding how much you want to contribute, is also a decision of what TYPE of contribution you want to make. According to CNBC over 86% of 401(k) plans now offer both contribution types – Traditional or Roth.
But which one is right for you?
Here is a quick recap of the two types of contributions you can make – Traditional or Roth
Traditional (deductible) contributions
You will receive a current tax deduction for the contributions now. This will save on taxes in 2023 and will help with cash-flow. In the future when you go to use these funds you will have to pay taxes and will have less money available upon withdrawal. If you are in a top tax bracket (35% and above) it is likely hard to pass on the current deduction (even if tax rates move slightly higher).
Roth (after-tax) contributions
You will be taxed on the amount of these contributions now but the account will grow tax-free and will not be subject to taxes upon withdrawal. This will likely mean you have less cash-flow now. But if you are in a low to moderate tax bracket (24% or below) this may make sense to consider.
Potential Tax Changes Coming
Now – back to which type of contribution may make sense. As it currently stands, tax rates and brackets will go up in 2026 unless congress takes action to change it. This means that for almost everyone Roth Contributions will become less advantageous at that time. Additionally, federal deficits have ballooned since the onset of the Covid-19 pandemic. This coupled with higher interest rates increases the chance that taxes will need to go up at some point in the future.
This is all to say that the next several years may be some of the best years to capture Roth type contributions.
Benefits of Roth Type Accounts
I was recently featured in an article discussing some of the benefits of Roth type accounts. One of those items is that once in an IRA vehicle you can consider being more aggressive with the investments in those accounts. This will allow for even greater wealth creation as the accounts will likely have larger tax-free growth in the long-run.
Planning Opportunity – For those who want to think much longer-term Roth accounts are also amazing estate planning and asset transfer vehicles. They will save your children and heirs significant tax dollars.
Benefits of Traditional Deductible
The main benefit of using this account is reducing taxes now. For earners in a top bracket this is tends to be an important concept. This leads to more money in your pocket now. However, tax savings from using this type of contribution would ideally be captured and invested in another type of account such as a 529 fund or regular brokerage account. If tax savings are spent and not saved you may have been better off contributing on a Roth basis.
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GuidePoint Financial Planning - Reston Financial Planning
Ryan Phillips, CFA, CFP® is the founder of GuidePoint Financial Planning. He is passionate about helping busy families plan, save, and invest for their financial future. Contact him today if you are interested in learning more about the benefits of working with a fee-only (no-commission) financial planner.