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Is it time to reconsider Roth contributions?

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A Roth IRA offers significant benefits for retirees. As an after-tax account, distributions from Roth IRAs are generally tax-free. This can save you a lot of money in retirement, but at the expense of tax payments while you save. You spend more today to build your portfolio, but save money later.

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For example, suppose you are married and in your late fifties. You and your spouse have a 401(k) with $1.6 million and are building a strong retirement. Would You Benefit from Switching to Roth Contributions?

In this case, most households could benefit from sticking with their pre-tax contributions, but the answer will depend on a number of factors. Here’s how to think about it.

As an after-tax account, a Roth IRA offers no upfront tax deduction or credit for your contributions. The benefit comes in retirement when you can withdraw your money tax-free.

This is the reverse of a tax-deferred retirement account, such as a traditional IRA or 401(k). Such accounts provide an income tax deduction on all contributions – up to annual contribution limits – for the year in which they are made. You then pay income tax on all withdrawals (both returns and principal) at retirement.

Upfront taxes are the biggest disadvantage of a Roth IRA. The money you spend on taxes is capital that you could otherwise have invested in long-term tax-deferred growth. For example, suppose you pay an effective tax rate of 20%. With a Roth IRA, you would need to earn $1.20 for every $1 you save to account for taxes on your contribution. A 401(k), on the other hand, allows you to save and invest the entire $1.20 of pre-tax income.

But there are significant advantages to Roth IRAs. First, and most notably, you can keep any money you withdraw from this account (provided you follow a few rules). In contrast, all withdrawals from a 401(k) are effectively reduced by your income tax rate.

Second, a Roth IRA is great for maximizing growth. The longer this portfolio grows, the more value the tax-free withdrawals will have. Third, Roth withdrawals can help you keep taxes on your Social Security benefits low because they don’t increase your taxable income.

Fourth and finally, Roth IRAs are not subject to required minimum distributions (RMDs), so you can keep the money invested for as long as you want.

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If you’re unsure whether a Roth IRA is a good option for your financial circumstances, consider talking to a financial advisor.

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