With apologies to Shakespeare, to change a line from one of his greatest plays, "to Roth or not to Roth, that is the question/Whether 'tis better to suffer the tax now, and reduce my forture, or hold it tight..."
More than a few of us feel like Hamlet come tax time when we struggle with this question and think long and hard on it. As we get ready for Tax Day in April, it's good to review some of the advantages of suffering "the slings and arrows" of paying taxes now in order to secure future benefits.
From just $107.88 $24.99 for Kiplinger Personal Finance
Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
First, there's that tax bite. Ouch. It's hard to let go of those funds when you could simply enter a traditional IRA contribution on Line 32 on the front of your 1040 for an immediate reward of less taxes. But you need to look ahead before doing that. You need to ask yourself when you have retired, do you expect your taxable income to be higher or lower than it is today?
As you are doing your taxes and comparing this year's tax bill and income to last year's, where do you stand? The goal is to pay the tax on the Roth contribution when you expect your tax bracket to be the lowest. If you are having a higher-income year, it may not be the best time to make a Roth contribution. If your bracket is lower in retirement, you may want to wait and work on a Roth conversion strategy at that stage of life. If this is the year your income is lower than you expect it will be in retirement, then by all means contribute to the Roth.
On the other hand, if your current tax bracket will be the same in retirement, it’s a wash and the old adage of putting off paying taxes as long as possible could be the right way to go. Looking ahead here could lead to another wrinkle. If you are married, the day will eventually come when one of you will pass on, leaving a single spouse. Tax brackets change dramatically when your status changes from married filing jointly to filing as a single taxpayer. You may slip into the next higher bracket even if you have lost some Social Security income due to your spouse’s passing.
The next question then becomes: Is it appropriate to convert some of the IRA funds into a Roth while you are in the lower married tax bracket, thus reducing taxable RMD income, in order to potentially reduce the impact of the higher tax bracket when the time comes that the survivor will file without the married benefit?
Also keep timing in mind. There is a five-year rule in play. While you can withdraw your contributions to a Roth without penalty or taxes at any time, the same is not true of the earnings. Think of it like a clock that says that you must have owned the Roth for five years and be older than 59 1/2 before the earnings may be withdrawn tax-free (there are some special exceptions that apply).
The actual wording of the rule states five “tax years,” which start Jan. 1 of the year for which you open and contribute to the Roth. If you open and contribute to the Roth by April 15, 2017, you can claim the contribution for 2016, causing your five years to start on Jan. 1, 2016. You have 16 months of actual time from the five-year wait. Subsequent new contributions and other Roths do not have their own five years (this is not addressing Roth conversions, which have a second five-year rule). It all starts when you open and fund that first Roth account.
Simply put, you could meet the five-year rule in as little as three years and eight months. Once you have opened and funded a Roth and met the time requirement, you have met it forever. Keep in mind this is a hard-and-fast rule. Should you pass away, the account still must meet the five -year rule before earnings, not principal, can be withdrawn tax-free for your beneficiaries.
Remember, due to your growth being tax-free, you should try to put your highest-earning and least tax-efficient investments in this account. Even with Tax Day looming, you might as well give yourself the most Roth reward possible. No point in playing Hamlet on this one.
See Also:Why You Need a Roth IRA
Nancy Fleming, CFP®, is the president of Fleming Financial Services, based in Gilbert, Arizona. She is an Investment Adviser Representative and licensed insurance professional.
-
AI Stocks Lead Nasdaq's 398-Point Nosedive: Stock Market TodayThe major stock market indexes do not yet reflect the bullish tendencies of sector rotation and broadening participation.
-
Top Tech Gifts to Grab at Walmart Before ChristmasBig savings on Apple, Bose, HP, Vizio and more while there's still time to shop.
-
AI Appliances Aren’t Exciting Buyers…YetThe Kiplinger Letter Artificial intelligence is being embedded into all sorts of appliances. Now sellers need to get customers to care about AI-powered laundry.
-
Quick Question: Are You Planning for a 20-Year Retirement or a 30-Year Retirement?You probably should be planning for a much longer retirement than you are. To avoid running out of retirement savings, you really need to make a plan.
-
Don't Get Caught by the Medicare Tax Torpedo: A Retirement Expert's Tips to Steer ClearBetter beware, because if you go even $1 over an important income threshold, your Medicare premiums could rise exponentially due to IRMAA surcharges.
-
I'm an Insurance Pro: Going Without Life Insurance Is Like Driving Without a Seat Belt Because You Don't Plan to CrashLife insurance is that boring-but-crucial thing you really need to get now so that your family doesn't have to launch a GoFundMe when you're gone.
-
I'm a Tax Attorney: These Are the Year-End Tax Moves You Can't Afford to MissDon't miss out on this prime time to maximize contributions to your retirement accounts, do Roth conversions and capture investment gains.
-
I'm an Investment Adviser: This Is the Tax Diversification Strategy You Need for Your Retirement IncomeSpreading savings across three "tax buckets" — pretax, Roth and taxable — can help give retirees the flexibility to control when and how much taxes they pay.
-
Could an Annuity Be Your Retirement Safety Net? 4 Key ConsiderationsMore people are considering annuities to achieve tax-deferred growth and guaranteed income, but deciding if they are right for you depends on these key factors.
-
I'm a Financial Pro: Older Taxpayers Really Won't Want to Miss Out on This Hefty (Temporary) Tax BreakIf you're age 65 or older, you can claim a "bonus" tax deduction of up to $6,000 through 2028 that can be stacked on top of other deductions.
-
Meet the World's Unluckiest — Not to Mention Entitled — Porch PirateThis teen swiped a booby-trapped package that showered him with glitter, and then he hurt his wrist while fleeing. This is why no lawyer will represent him.
