It is a question… use the Roth-type accounts, or go for the immediate tax deduction now.
In American personal finance, it’s a choice many need to make: use a Roth IRA or Traditional IRA; use a Roth 401k vs. a Traditional 401k
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Words
Much ink has been spilled on the differences between Roth and non-Roth accounts, so I don’t need to review them here. I’ve been retired now for more than four years, and started RMDs three years ago, so I have real world experience with the business end of the debate.
Most of the discussion I have read are about the practical difference between the two types of accounts. I will give my perspective.
Working
While I was employed, I was able to utilize the regular 401k plans available the the time, and I surely appreciated the tax savings at the time. And I was able to make some contributions to both Traditional and Roth IRAs over the years. So I am familiar with both sides of the story.
Retired
Now that I retired, and receive Social Security, and am subject to RMDs, my situation is different than my working days. As it happens, the majority of my income now comes from RMDs. In addition, there is the Social Security benefit, and I receive dividends from my portfolio, and some capital gains from some mutual funds.
While I was working, my focus was on maximizing my income and being sure to maintain my investing. Now that I am retired, my income is more or less fixed, as I have no influence over much of my income. The Social Security benefit is fixed by annual government edict. RMDs are based on IRS rules and a percentage which changes annually. Dividends are determined by the boards of directors of the companies in which I own stock. (I could reduce my dividends by selling shares, but the purpose of the shares is to get dividends, and I also prefer not to sell, and so I avoid most capital gains as much as possible.)
My income is more or less predetermined by the decisions of others. As taxes are a function of income, so my taxes are as well predetermined by the decisions of others.
Two Factors
There are two factors that determine the RMD amount. The RMD amount is based on a percentage of the amount of one’s tax deferred accounts. This percentage is set by the IRS, and it increases every year. The second factor is the balance of tax deferred accounts as of December 31 of each year.
The balance of my accounts is another thing out of my control. If the value of my accounts goes up, my RMD amount increases, as also does the taxes on the RMD. If the market is down, the RMD amount may be lower because of lower value, but may be higher regardless because of the annual percentage increase in RMD calculation.
Attention
Tax planning awareness has become more significant to me now that I am retired. While there are many places I cannot affect my taxes, there are a few where I can. And looking back, I have some recommendations (see below).
Taxes
There are a few places I can affect my taxes. One is donations. Since donations to charities are tax deductable, by making donations, I can reduce taxes. I have been making donations for many years, and will continue to do so. The vagaries of the tax law make the standard deduction in most and recent years more tax-efficient for many people rather than iby using temized deductions, which could theoretically reduces the tax need for charitable contributions.
One area I will be considering is using a qualified charitable donation (QCD). This allows making a charitable donation from a tax deferred account directly to a charity. This amount of the QCD reduces the taxable portion of the required RMD I must take, up to a certain limit. I still would need to pay taxes on the portion of the RMD which is not sent to a charity.
Looking Back
I have basically locked in my tax situation by having contributed to regular 401k plans and traditional IRAs when I was working, and as mentioned, enjoyed the tax benefits at the time. However, now that I am retired, I would think that if I had foregone the tax benefits of 401k payroll deductions and focused on Roth and non-deductible IRAs would have made my present tax situation far more comfortable (namely, significantly less tax now). But since I cannot redo the past, it is only an academic exercise to consider what I could have done.
What are you doing about taxes in retirement? Let me know here.
The Peacock Side Chair was designed by Frank Lloyd Wright as part of his redesign of the Imperial Hotel in Tokyo, Japan. Courtesy the Smithsonian Institution. Creative Commons (CC0) license.
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