Have you been following along? In our attempt to dispel myths surrounding retirement savings and how it affects your taxes, I think we’ve learned a lot. Have you learned some new things? What has been your favorite so far?
Let’s look more closely. We have learned how the Traditional 401k and Roth 401k work. We have also taken a look at what it says in your enrollment booklet. A lot of those booklets mention tax savings that we have been looking for all along. We just can’t seem to find it yet.
In episode I: Tax Savings, Where’s That?, we saw that even if we save the money we don’t have to pay in taxes it probably won’t be enough to offset the taxes we will have to pay later.
Then in episode II: Tax Savings, It’s In The Paycheck?, we saw that saving money pre-tax versus after-tax doesn’t mean you have more spendable income.
In the last reading, episode III: Tax Savings, Advantage Over The Roth?, we saw that, all things being equal, the Traditional 401k equals the Roth 401k in the long run.
With all these things what questions are left? One question you might have is that in episode I we demonstrated what happens if you save the supposed tax savings. Well where is that accounted for in episode III? You might even argue that your better off with the scenario in episode I because you’d have the extra $17,000. The problem is that all things aren’t equal between the two. See in episode II we established equal spendable incomes. Between I and III we have two different spendable incomes so these aren’t apples to apples.
What we are left with is that everything being equal, apples to apples, all things are the same. So it’s the almighty question, if you change the variables how does it affect the scenarios? Let’s look at it.
Taxes are probably the easiest one. If you think that taxes will go up in the future then it is more beneficial to contribute to a Roth. It’s taxed at today’s rates. Does anyone believe that taxes will be more favorable in the future?
The other main thing to look at is distribution regulations. The Roth has the definite advantage here. The biggest thing is not having to take withdrawals after the age of 70½. This allows your money to continue to benefit from tax-deferred growth. There can also be more flexibility with early access of a Roth account, definitely an IRA and depending on plan documents, a Roth 401k, as you may have access to the contributions at anytime.
Now that we’ve looked at some fallacies surrounding your Traditional 401k, has it changed your opinions at all? Is it going to change your behavior? You need to ask yourself where do you want to be in retirement. Is your goal to live off less money? Chances are you will have a lot less tax deductions, if any. There seems to be a trend of taking those away from taxpayers, don’t you think? Maybe you’ll have less expenses, pay off the mortgage? Or maybe you’ll have higher expenses trying to keep up with health care or your hobbies? I mean you need something to pass the time that you previously spent working and if it’s not making money then it just might be spending it, right?
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