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How to Pick a Retirement Account
Taxes, income and expenses help determine what type of Individual Retirement Account is appropriate for your needs.
Whether you’re starting your career, approaching retirement or somewhere in between, it’s important to understand the various options available to help you reach your retirement goals. Even if you are already investing in a 401(k) or other retirement plan, contributing to an Individual Retirement Account (IRA) can help you diversify your investments and provide an additional tax-advantaged savings plan.
So, what’s the difference between a Roth and Traditional IRA, and which is appropriate for you?
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3 Things to Consider when Choosing an IRA
1. Tax Rates
Will your taxes be higher now or later?
“This is often the top consideration for people when choosing whether to contribute to a Roth or traditional retirement account,” says Mary Ellen Hancock, a senior wealth strategist with PNC Wealth Management Certified Financial Planner and Master of Science in Taxation.
On the face of it, the decision appears straightforward, she explains. If you expect your tax rate will be lower when you retire, a traditional account may offer you more spendable income for retirement. If you expect your tax rate will be higher than it is now or the same upon retirement, a Roth account may provide you with more spendable income later. The challenge is there is no way to know what future tax rates will be, and even if you had a crystal ball, other (following) factors should be considered.
2. Retirement Income and Expenses
“Understanding your spending before you retire can help you have a smoother and more successful transition as you begin your next chapter,” says Hancock. “It’s important to assess what income and expenses may be eliminated when you retire and what new expenses may be added.”
Hancock explains that withdrawing from a traditional account to pay for unexpected expenses during retirement can result in unpleasant consequences, such as higher Medicare premiums, more of your Social Security benefits being taxed or raising your tax bracket. On the other hand, qualified withdrawals from Roth accounts are tax free and should not affect your taxable income or treatment of Medicare and Social Security benefits.
3. Required Minimum Distributions
“Roth options may have some advantages over traditional accounts, as you do not need to start withdrawing at age 70 ½ ,” she says. “Traditional accounts, both 401(k)s and IRAs, require you to withdraw money once you reach age 70½, which limits the account’s growth potential.”
For many individuals, using both Roth and traditional accounts may help address some of the uncertainty over your future tax bracket and whether your spending needs may change. There are IRA contribution limits set each year by the Internal Revenue Service, so it’s important to check with the IRS website, your financial planner or tax advisor on how much you can contribute to each.
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Mary Ellen Hancock explains that there are three important factors to consider when deciding between traditional and Roth IRAs.
Determining your Retirement Income & Expenses
Consider working with a financial advisor to estimate your post-retirement budget. Some considerations include:
- Will you have a mortgage?
- Do you plan to live in a state with high property taxes?
- Do you have other debt?
- Do you plan to buy a second home or travel?
- If you live far from children and grandchildren, how much do you expect it to cost you to visit them?
- Is there a chance you might be looking after your grandchildren while your children are working? You may be picking up the so-called “pocket change” items.
- If we were to fast-forward to when you are in your 80s and 90s, what type of long-term care coverage do you have in place? Are you planning to self-insure? Depend on social services?
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The material presented herein is of a general nature and does not constitute the provision by PNC of investment, legal, tax, or accounting advice to any person, or a recommendation to buy or sell any security or adopt any investment strategy. Opinions expressed herein are subject to change without notice. The information was obtained from sources deemed reliable. Such information is not guaranteed as to its accuracy.
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