Tax-Smart Retirement: Choosing Between Roth and Traditional Accounts

Ready to optimize your retirement savings strategy? Let's clear up some confusion about Roth vs. Traditional retirement accounts that might be costing you thousands in future tax benefits.

First, let's bust a common myth: there are NO income limits for Roth 401(k) contributions! While Roth IRAs do have income restrictions, your salary never disqualifies you from making Roth 401(k) contributions if your employer offers this option. And starting next year, highly-compensated employees over 50 will need to make their catch-up contributions as Roth.

Traditional accounts give you an immediate tax break by reducing your taxable income now, with taxes due on both contributions and earnings when you withdraw in retirement. Roth accounts offer no immediate tax deduction, but qualified withdrawals in retirement—including decades of compound growth—come out completely tax-free.

For early-career savers, I generally recommend Roth contributions regardless of income. The power of tax-free compounding over 30-40 years typically outweighs immediate tax savings. Mid-career professionals face a more nuanced decision based on current tax situations and future tax rate expectations. Pre-tax contributions can strategically keep your income below thresholds for valuable tax benefits like the expanded SALT deduction or child tax credits. Meanwhile, Roth IRAs offer a hidden emergency fund feature—you can withdraw contributions (not earnings) anytime without penalties.

Running scenarios through tax software can help quantify the difference between these options for your specific situation. But remember, while saving strategically matters, I've never met anyone who regretted saving too much for retirement—just don't forget to enjoy life with loved ones along the way!

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Envision Financial Planning. 5100 Poplar Avenue, Suite 2428, Memphis, TN 38137. (901) 422-7526. This communication is strictly intended for individuals residing in the United States. Advisory Services offered through Envision Financial Planning, a Registered Investment Adviser.

Chapters

• 0:00 Introduction to IRA and 401(k) options
• 1:24 Traditional vs Roth key differences
• 2:30 Who should choose Roth accounts
• 3:50 Tax planning considerations
• 6:32 Contribution deadlines and final thoughts

Transcript

Speaker 1: 0:00

Hi, I'm Stacey Hyde and I'm back for another episode of Better Financial Health in 15 Minutes or Less, and today I want to revisit the old traditional IRA versus Roth IRA or, depending on your situation, traditional 401k versus Roth 401k. The first thing I'd like to talk about in those two is a common misconception I get. Thing I'd like to talk about in those two is a common misconception I get. I recommend that someone should contribute to their Roth 401k and they tell me they can't because they earn too much money. That's actually not true. There's no income limit on a Roth 401k. Yes, there are income limits on a Roth IRA, but if your employer gives you the option to choose between traditional pre-tax or Roth after-tax, it doesn't matter what your income is. You can still make those Roth contributions. So that's a neat feature that's available Starting next year if you're considered highly compensated by your employer. There's income rules. Your employer will let you know. Generally speaking, it's around $165,000, but they haven't set those amounts for next year yet and you're over 50 and want to make catch-up contributions, you will actually have to make those as Roth 401k. So little note there before we kind of get into it.

Speaker 1: 1:25

So just a refresher traditional IRA is pre-tax, meaning it comes out before federal and, if you're subject to it, state income tax. The money grows tax deferred and then when you're in retirement and take it out, you pay taxes on both what you put in and any earnings. Also, if you take the money out before you're 59 and a half, then you're subject to an additional 10% penalty tax. So let's talk about Roth. Roth is made with after-tax contributions. So after federal, after state taxes, the money grows tax-deferred and as long as you abide by the rules which means money's been in there for five years, you're at least 59 and a half you can take that money out and pay no tax on either what you put in or your gains, which can be significant if you started early. So let's talk about who might be a good candidate for Roth versus traditional Early career.

Speaker 1: 2:32

I really don't care how much money you make. I'm going to generally recommend that you make a Roth contribution. Here's why you have so many years for that tax-free compounding to grow that, unless you're in just a very high bracket, you had some weird year that pushed your income up and it's expected to drop back next year. You're likely going to want to make those into raw to take advantage of the compounding over overtime and the tax-free nature of that. So that's the first group. Then you get into mid-career and you get into well, maybe it really is going to depend on your situation.

Speaker 1: 3:18

For many folks they still have a lot of deductions. Maybe they have some kids, some child tax credits, maybe the spouse is not working as much due to child care issues but income's just kind of lower overall. The Roth is still going to likely make sense. But if you're higher up in there, it really gets into what. Do you think tax rates are going to be in the future? If you think that tax rates are likely to be higher in the future than they are today, you're likely better off to go ahead and pay those taxes now.

Speaker 1: 3:56

So the but you also have to pay attention because with the one big beautiful bill act, if you have the ability to make pre-tax contributions and you're married, filing jointly, and your income is real close to that five hundred thousand dollar limit, well, if you go over that five hundred thousand dollar limit, your ability to deduct same local taxes can drop from $40,000 all the way back to $10,000. So that can really catch you there If you make your 401k contributions pre-tax, that is going to lower your adjusted gross income. It doesn't matter how many deductions you have, it's only that adjusted gross income number, that adjusted gross income number. So if you're trying to hit the part where you still qualify for the child tax credit, that can be a reason to do pre-tax 401k or IRA there. So the other thing to keep in mind is that if you make Roth IRA contributions and you get into a financial hardship, you can withdraw your contributions without tax or penalty. So that is sort of a backdoor way into an emergency fund. That could really help you out at some point. You can't get to the earnings without the taxes and penalty, but you can get to your principal, so that could be very helpful to you there. So there's a lot of good there.

Speaker 1: 5:33

As you can probably tell, I'm a big Roth fan. I do firmly believe that when you look at the deficits and what's going on in the world, we're likely to see higher tax rates in the future. We're likely to see higher tax rates in the future. So I think that paying some tax now and setting up that tax-free bucket for later makes sense. So but each person's situation is unique.

Speaker 1: 5:57

If you do your own taxes. Um through, like turbo tax or h&r blocks tax software, you may want to go back and look and pretend as though you did a Roth IRA contribution and see what the difference in your taxes was if you had done pre-tax versus Roth, because you may come out that one is better than the other. The other thing that's nice is you do have until April 15th of next year to make a traditional IRA or Roth IRA contribution in pre-tax. Take that out and then put it in as Roth and see how much contributing into a Roth is going to quote-unquote cost you in extra taxes. You may find out that you're you make too much money because you're covered by a qualified plan at work and you're not allowed to do a traditional. So if you're wanting traditional, you'll need to do that figure 401k, but that you you have to do that during the calendar year for which it applies. There's really not any flexibility there.

Speaker 1: 7:13

So go forth, save. I've never had anybody be sorry that they had saved too much for retirement. The only thing that I ever tell people to do is don't get so focused on saving that you forget to enjoy time with family and friends today. Have a great rest of your week. Thanks for tuning in. This has been another episode of Better Financial Health in 15 minutes or less.