When it comes to managing your money, most people focus on investment performance. But there's another consideration that is just as important: how much you keep after taxes. Looking at your account balance without understanding taxes is like checking your paycheck before deductions—the number looks great until you see what gets deposited in your bank account. For years, people assumed that they would earn less money and pay lower taxes in retirement. That's not necessarily true today, especially if you've saved well and want more than just Social Security income to live on. Let’s look at the tax differences between Traditional and Roth Retirement Accounts.
Traditional Retirement Accounts like IRAs and 401(k)s have helped millions of Americans save for retirement. But here's the catch - when you withdraw money from these accounts, the IRS taxes every dollar as regular income.
Roth IRA accounts were created in 1997 as a different option. With a Roth account, you pay taxes on your contributions now, but your withdrawals in retirement are tax-free. Today, in addition to Individual Roth Accounts many companies offer Roth options in their employee 401K retirement plans.
Here's the choice: Pay Now or Pay Later?
- Traditional IRA / 401(k): Get a tax break now, then pay taxes later during retirement on your contributions plus the growth
- Your heirs pay income tax on everything they inherit.
- Under current law, most non-spouse beneficiaries must withdraw the entire account within 10 years after your passing.
- If your children inherit during their peak earning years, they could lose 40-50% to taxes.
- Roth IRA / 401(k): Pay income taxes now on your contributions, then withdraw all dollars including growth, tax-free in retirement
- Roth Accounts are always tax-free.
The traditional option gives you a bigger paycheck today which sounds appealing. However, we often recommend clients choose the Roth option because traditional qualified assets are taxed differently than non-qualified assets during retirement and when passed along to beneficiaries.
Benjamin Franklin said it best: death and taxes are life's only certainties. While no one enjoys paying taxes, they're our membership fee for living in a functioning society paying for roads, police, schools, and other essential services.
Most people want to leave their legacy in this order:
- Family and loved ones
- Charitable causes they care about
- Taxes (only what's legally required)
The Bottom Line
Good wealth management isn't just about making money grow. It's about coordinating three things: Tax planning, along with Investment strategy and Legacy planning. This ensures more of your money goes where you want it to go.
If you manage your own finances, you may already know this information and have things well organized. If you work with a financial advisor, bring up these topics at your next meeting to make sure your plan is tax efficient.
And if you're looking for a wealth management firm, feel free to reach out. We're a family-run business and would be happy to meet and see if we're a good fit for each other.
Wishing you much success, Ron
Securities and Advisory Services offered though LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.