To Roth or not to Roth? That is the question—at least for those of us who want to retire someday. With so much emphasis today on saving for the future, making informed decisions for your retirement vehicle can be tricky. We’ve all heard about Roth IRAs. And now, there are Roth accounts in retirement plans. So what is this “Roth” business that is causing all the excitement?
Traditional IRA or pre-tax retirement plan contributions are not taxable when contributed. Making these kinds of contributions typically lowers the taxes you pay in the current year because the money isn’t included in your income. When you withdraw it later, that’s when you pay taxes on both the money you contributed and earnings.
Roth contributions, to both a Roth IRA and a retirement plan (such as a 401(k)) that has adopted a Roth option), are taxed when contributed. However, those contributions will not be taxable when you withdraw them later. If you have money in your Roth account for at least 5 years, and you wait until you are 59½ to withdraw it, the earnings on your contributions will also be tax free.
Roth IRAs and Roth accounts in a retirement plan have the same basic principles -- but there are important differences to note. First, Roth IRAs have a current maximum contribution of $5,500 ($6,500 if you are age 50 or older). This $5,500 is a combined maximum for all IRAs, both traditional (pre-tax) and Roth. Second, there are income limits for eligibility to contribute (currently $127,000 for single taxpayer; $188,000 for married taxpayers filing jointly).
Contrast this with Roth accounts in retirement plans, which have a current maximum contribution of $17,500 ($23,000 if you are age 50 or older). This $17,500 is a combined maximum for your entire retirement plan account, both pre-tax and Roth contributions. There is no income limit for eligibility; however, not all retirement plans have adopted Roth contributions.
If you are a PERA member, both the PERAPlus 401(k) and 457 plan will soon have an optional Roth contribution feature available. PERA employers will have the option to elect this for their employees to have access to Roth contributions. All PERA members, regardless of whether your employer has elected to participate in the Roth option, will be able to roll in Roth money from other retirement plans into their accounts in the 401(k) and, if applicable, the 457 plan.
There are also opportunities to change pre-tax money into Roth money. Although you pay tax on the amount that is changed to Roth (which can be a large tax burden because there is no withholding), earnings from that point on will not be taxed at withdrawal as long as the 5-year and age 59½ rules are followed. If money goes from a traditional pre-tax IRA to a Roth IRA, it is called a “conversion.” If money goes between a pre-tax account in a retirement plan to a Roth account in that same retirement plan, it is called an “in-plan rollover.”
The PERAPlus 401(k) and 457 plans will, in the future, allow in-plan rollovers. These conversions/in-plan rollovers are a good way to change the tax treatment of money that is already in your IRA or retirement plan account without making any additional contributions to a plan.
So we get back to the question: to Roth or not to Roth? It depends on several factors—your current income tax rate, your retirement goals, and your personal level of comfort with market growth. Because no one can say what tax rates will be like in the future, there is a level of uncertainty with putting off taxation of contributions until later. People who feel this way may want to utilize Roth contributions, if they can leave the money in for at least 5 years.
The fact that the earnings on your Roth contributions will never be taxed (if you meet the IRS age and 5 year requirements) is a big incentive to have Roth contributions in your plan. But, at the same time, if you think you will be in a lower tax bracket at retirement, and if you want to lower your current tax bill, it may make more sense to make pre-tax contributions. This doesn’t have to be an all-or-nothing situation—don’t forget, it is possible to do a mix of pre-tax and Roth contributions. (In fact, one of the most attractive features of using a Roth is the ability to do just that – it gives you tax diversification.)
Now that you know the basics of Roth, you can start researching your options and figure out what makes sense to you. Good luck and always remember to read the fine print.
This post was written by Megan Westberg, a Staff Attorney at Colorado PERA. Would you like to write a guest post for The Dime? Email us at firstname.lastname@example.org