20 years ago I and my industry hounded everyone to defer as much income as possible to retirement because one’s income would be less and tax rates lower. Then 10-12 years ago I advised “tax diversification”, half your retirement money should be taxable, half tax-free. That way if your savings plans were successful, and you retired into a higher bracket, you could take the tax-free income first. If your bracket was lower, you could take the taxable income first and let the tax-free portion keep building.
But now several factors have created a perfect storm of big tax increases in the near and long term:· Current tax rates are the lowest since the 1920’s
· As a % of GDP, the Federal deficit is the highest since WWII
· The boomers will skyrocket demand for Federal entitlements
So regardless of whether your income is lower in retirement we will all most likely pay higher tax rates. What should you do? Here are my recommendations:
1. If you have a matched retirement plan at work, keep contributing enough to get every matching dollar. That’s free money.
2. If you can still afford to save more, ask your employer about a Roth 401(k). Employers have been able to do this with 401(k) & 403(b) plans since 1996.
3. If they won’t accommodate you, set up Roth IRAs if your income level qualifies.
4. Convert Traditional IRAs & accessible retirement accounts to a Roth IRA. If your single or joint income exceeds $100,000 you can do this starting in 2010. This is a perfect time to take the tax hit: low account values and low tax rates.
5. Want to bypass most of the conversion restrictions? You can do a strategic rollout into other financial vehicles that will be tax-free to you and your kids. Some even have long term care benefits & minimum guaranteed returns built in. Effective January 1, some previously taxable withdrawals can now be tax free. And, you can avoid the pre-age-59 1/2 excise tax through reg. 72(t) distributions.
Of course, it is always dangerous to take any action without expert analysis and advice. It’s possible none of this would work for you and could actually be harmful. Please don't do it yourself. The first step? Take my Wealth Index Questionnaire while it is still free. It takes 15-20 minutes online. Then when your results are in, we'll spend an hour reviewing them in a face-to-face meeting.
Best Regards always,