A CFP Poked Holes in My Traditional vs. Roth Strategy—Does It Still Hold Up?
Nov 8, 2023
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CFP, Eric Jones, debunks the traditional vs. Roth strategy with Katie, discussing factors like social security benefits, tax implications for business owners, tax optimization strategies for retirement, and reasons for working past retirement age.
Financial planning involves numerous variables and assumptions that can impact the effectiveness of different strategies.
The debate between traditional and Roth 401k contributions is explored in-depth, highlighting the importance of considering factors like Social Security benefits and required minimum distributions (RMDs) in retirement income calculations.
Tax planning and flexibility are crucial for individuals considering early retirement, as executing tax strategies can be complex and require careful consideration of taxable income on healthcare plan tax credits and Medicare premiums.
Deep dives
The Complexity of Financial Planning
Financial planning involves numerous variables and assumptions that can impact the effectiveness of different strategies. Factors like income, lifestyle, retirement age, tax rates, and future market conditions all play a role in determining the best approach. However, the uncertainty surrounding these variables and their potential changes over time can make financial planning challenging and potentially unreliable.
Traditional vs. Roth 401k
The debate between traditional and Roth 401k contributions is explored in-depth. The traditional strategy, which involves making pre-tax contributions to a 401k and investing the tax savings in a Roth IRA, offers potential tax diversity and more investable dollars. However, the analysis assumes a retiree will live beyond 59 and a half and have a high income and savings rate. The episode also highlights the importance of considering factors like Social Security benefits and required minimum distributions (RMDs) in retirement income calculations.
The Impact of Social Security and RMDs
Social Security and required minimum distributions (RMDs) can significantly impact retirement income and tax rates. While Social Security benefits are subject to change, considering them can provide a more realistic retirement income estimate. RMDs, which start at age 72, can increase taxes in retirement, and early retirees have more flexibility to mitigate their impact. The analysis shows that tax-advantaged strategies like traditional 401k contributions can lead to higher inheritances compared to Roth strategies, especially when considering the compounding power of additional investment dollars.
Importance of Tax Planning and Flexibility in Early Retirement
Tax planning and flexibility are crucial for individuals considering early retirement. While retiring early may provide opportunities to take advantage of lower tax brackets, there are limitations. Executing tax strategies can be complex, and the interplay of taxable income on healthcare plan tax credits and Medicare premiums can have significant implications. Furthermore, required minimum distributions (RMDs) can pose challenges. RMDs increase every year and can create tax constraints, particularly as distributions exceed the safe withdrawal rate. Considering these factors, it is important to carefully plan taxes throughout retirement to ensure financial stability.
The Impact of Inheritances and Estate Planning on Taxes
Inheritances and estate planning play a significant role in tax minimization strategies. Minimizing taxes on wealth, regardless of when they are paid, is a priority. Failing to plan ahead can result in beneficiaries paying estate taxes and potentially higher income taxes. Transferring wealth to the next generation involves considerations such as capital gains, cost basis, and Roth accounts. Although estate taxes may not affect most individuals due to high exemption thresholds, tax-deferred accounts' inheritance rules have recently changed. Non-spousal beneficiaries now have ten years to liquidate a traditional IRA, creating potential tax implications. While inheritances may not be a concern for everyone, they should be considered within a comprehensive tax planning approach.
If you’re a regular listener, you probably know that we already did an “ultimate” Traditional vs. Roth 401(k) episode this year. “Katie,” you might be saying, “Do you mean to tell me that the ultimate strategy was…*gasp* wrong?”
