Tax me now or tax me later. Roth v. Pretax

In 1817, Benjamin Franklin stated, “In this world nothing can be said to be certain, except death and taxes.” It is true, we can’t avoid taxes and we can’t avoid death.   But, there are investment options available for us to potentially reduce our tax liability. In this example, I am referring to any Roth investment type. It can apply to Roth IRAs, Roth 403(b)s and Roth 401(k)s.

With a Roth investment, you to pay the tax liability on the investment at the time of initial contribution. This is done by funding the Roth investment with already taxed dollars; i.e., from a savings account or checking account for IRA’s, or an after-tax deduction for employer-sponsored 403(b) or 401(k) plans. If a distribution is taken from a Roth account after age 59 ½, ordinary income taxes are not required. For an example of how this may impact you:

• You invest $1,000 into a Roth investment and you paid a hypothetical income tax of 20% or $200 on this investment.
  • Let’s say your $1,000 investment doubles in 10 years to $2,000.
  • In another 10 years it doubles again to $4,000.   
• You are now over age 59 ½ and you take a distribution from your Roth investment; your tax liability on this investment was based on the initial investment and paid at initial investment.
  • Any distribution you take after age 59 ½ is not subject to ordinary income tax; therefore, your tax liability was $200.

Let’s contrast this to a pre-tax investment (Traditional IRA, 403(b), 401(k)). With a pre-tax investment, you do not have a tax liability at the time of initial contribution.  Your tax liability is deferred until you take a distribution.

• You invest the $1,000 into a pre-tax investment. At the time of initial investment, you are deferring your tax bill into the future.
  • Let’s say your $1,000 investment doubles in 10 years to $2,000.
  • In another 10 years it doubles again to $4,000.
• You choose to take a full distribution from this pre-tax investment, and you are over age 59 ½; so you do not have IRS early withdrawal penalties, but any distribution is subject to ordinary income taxes.  Remember, you deferred the tax liability, which is due upon distribution.  
  • If you took the full $4,000, at a 20% tax rate, your tax liability is $800. 

If you would like to discuss this concept further, how it may fit into your overall investment portfolio and eligibility, please give me a call. I look forward to speaking with you!

Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.  Past investment performance is not a guarantee of future results.   I am not a licensed CPA and cannot provide tax advice.  Withdrawals from the account may be tax free, as long as they are considered qualified.   Limitations and restrictions may apply.  Withdrawals prior to age 59 ½, or prior to  the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax.   Future tax laws can change at any time and may impact the benefits of Roth IRAs.  Their tax treatment may change.

1-742478