Like virtually all matters in your financial plan, when it comes to Roth IRAs… well, it depends.
As you may know, in simple terms, Roth IRAs let you put in after-tax dollars today in exchange for never paying taxes on those dollars again in the future.
A traditional IRA (or 401k), on the other hand, typically lets you put in pre-tax dollars today in exchange for current tax savings while paying income taxes on the dollars when they come out of the IRA (or 401k) down the road.
Bottom line: do you want the tax benefit now or later?
And, of course, it depends.
What does your tax profile look like today?
What will your tax situation look like once you’re retired?
Well, it’s pretty easy to get a handle on what your taxes look like today.
By the way, this is something I can help you with as I’m now providing tax planning (not tax preparation) for my clients. Get in touch to learn more…
Here’s where I have a problem with Roth IRAs…
Many financial advisors are convinced tax rates will be higher in the future.
And I’ll be the first to admit that they might be right.
However, based on this fundamental - and important - assumption, they argue that, if you can, you should “fill up” your lower tax brackets with Roth conversions in the years leading up to retirement (or even after you’re retired in some cases).
This involves taking money out of a traditional IRA or 401k and putting it into a Roth IRA. The problem is that this creates a taxable event.
You have to pay income taxes on these dollars.
And my question - one I don’t have an answer to - is how do they know?
How does anyone know what tax rates will be in 5 years let alone 25 years?
I sure as heck don’t know.
As a result, I’m generally not comfortable creating a taxable event today in the hope that the numbers work out in your favor years or decades from now.
Speaking of what your taxes might look like in retirement: