Is Now The Best Time To Invest In A Roth Retirement Account?

In December 2017, the GOP’s Tax Cuts and Jobs Acts, the biggest tax overhaul in 30 years, was passed into law (read our previous blog). Whether you’re a fan, critic, left, right, or just indifferent about the new tax laws, our goal is to find ways to make the changes work for you.

Starting with the 2018 tax year, we are going to experience what may be the lowest tax rates of our lifetime. That sounds great except that those low rates are temporary and are due to expire by 2026.  So when thinking about retirement, is now a great time to invest in a Roth?

To answer that question, let’s first go over what a Roth account is.

What is a Roth and how does it work?

You’re likely familiar with typical retirement savings plans such as a traditional IRA or 401(K), where you contribute pre-tax dollars now and pay taxes on that money when you withdraw from your account upon retirement. In summary, you don’t pay taxes on the income now, but you pay taxes on them later.

A Roth works in the opposite way –  you fund the retirement savings account with income that you’ve already paid taxes on. Those savings grow over time with investment earnings until you retire. After retirement, you can make qualified, tax-free withdrawals of your contributions and the investment earnings. In summary, you pay taxes on the income now so that you do NOT have to pay taxes on them later.

Using the Roth strategy is particularly attractive if your current tax rate is lower than what you expect your tax rate to be when you plan to retire.

For example, let’s say you’re single and your taxable income is $75K, and you decide to put aside $10K for retirement. You would be subject to a 22% marginal tax rate.

Fast forward 30 years – you’re married, your Roth account grew to $76K (tax-free), and now your joint income at retirement is $250K. Your marginal tax rate at retirement would be 33% (based on the pre- Tax Cuts and Jobs Act rates).

Let’s say part of the income of $250K is a qualified withdrawal from your Roth account in the amount of $70K. You would have a savings of $20,900 calculated as follows:

$70K x 33% = $23,100 (tax savings on Roth withdrawal) minus $10K x 22% = $2,200 (tax paid 30 years ago) equals $20,900.

* This example is only meant to convey the concept of the Roth and does not account for inflation, fluctuations in the market, and tiered tax calculation.

How do I know if I will be in a higher tax bracket when I retire?

While it’s difficult to know for sure what your tax rate will be in the future, what we do know is that the tax rates under this new law are very low and will rise after 2025. With that, chances are you will be in a higher tax bracket if you plan to retire or make qualified withdrawals after 2025.

A good approach is a balanced approach – so to the extent that you can, you should consider a strategy where you contribute to both a traditional retirement account and a Roth account.

Roth 401(K) versus Roth IRA

Similar to a traditional 401(K), a Roth 401(K) is an employer-sponsored investment savings account. However, unlike a traditional 401(K), the Roth 401(K) is funded with after-tax contributions up to a certain limit. For individuals under 50 years old, the annual limit is $18,000.

A Roth IRA is an account set up by you, the individual, and is not sponsored by an employer. The annual contribution limit is $5500 for individuals under 50 years old.

The two main differences between the Roth 401(K) and the Roth IRA are the annual contribution limits and that in most cases, contributions to the Roth 401(K) are matched by the employer.

If your employer offers a 401(K) plan, you should choose that over an IRA so you can contribute more and take advantage of employer matching.

Regardless of your politics, it’s important be strategic and to seize opportunities. We at Desnoyers CPA, LLC are here to help you maximize on your long-term goals.

Written by Desnoyers CPA

Desnoyers CPA

Known for her friendly, outgoing nature and her rare talent for financial foresight, Lydia Desnoyers has been serving individuals and small businesses in Florida since 2010. After earning her Master’s Degree in Accounting from Nova Southeastern University and her Bachelor’s Degree in Accounting from Florida State University, she became a Certified Public Accountant and a Certified Fraud Examiner.

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