Tax Strategies With Retirement in Mind

When it comes to how to save for retirement, there are enough options to make anyone's head spin. While each approach has its benefits, when it comes to taxes, not all retirement savings vehicles are created equal.
This post was published on the now-closed HuffPost Contributor platform. Contributors control their own work and posted freely to our site. If you need to flag this entry as abusive, send us an email.

When it comes to how to save for retirement, there are enough options to make anyone's head spin. While each approach has its benefits, when it comes to taxes, not all retirement savings vehicles are created equal. As April 15 approaches, now is as good a time as any to review the three "tax buckets" of retirement savings: tax deferred, tax-free and after tax. You want every saved penny to help you on your path to retirement readiness, so spend time during tax season to make sure you understand and are taking advantage of retirement savings options.

For most people, the tax deferred bucket makes up the bulk of their retirement savings through a workplace 401(k), 403(b) or traditional individual retirement account (IRA). Tax deferred accounts* tap pre-tax dollars, with retirees paying the taxes when the money is withdrawn in retirement. These savings lower your taxable income today and offer a convenient, easy way to save for retirement. Yet, retirees may not take into account the tax hit this bucket receives in retirement when they look at their total savings and plan retirement income. In addition, marginal tax rates could rise for retirees in the future, meaning a bigger bite out of savings down the road.

The second bucket of savings taps after tax money and lets earnings grow tax-free. Through a Roth IRA or Roth 401(k), contributions are after tax and no taxes are paid when the money is withdrawn in retirement. The Roth may benefit those who have more time to let the money grow tax-free. In addition, savers do not need to withdraw from the Roth when they turn 70½ as they do with a 401(k), 403(b) or traditional IRA. This means retirees can allow these savings -- which continue to compound -- to pass along to their heirs untouched. I often encourage retirees to withdraw their Roth savings last due to the tax-free growth potential.

If you have a Roth 401(k) available through your employer, you can put a maximum of $16,500 (note that any company match will be pre-tax dollars), while you can only contribute up to $5,500 into a Roth IRA annually. For investors over the age of 50, both the 401(k) and IRA have catch-up provisions ($5,500 for 401(k) and $1,000 for IRA annually). There are no income restrictions for the Roth 401(k), while income must be below $191,000 for married couples and $129,000 for single taxpayers to contribute to a Roth IRA. Despite the fact that some individuals can't contribute to a Roth IRA due to income restrictions, anyone can convert savings from a tax deferred savings vehicle to a Roth regardless of income level.

Given the benefits, I often get asked about converting dollars to a Roth. I usually encourage investors to have at least ten years for the money to grow in the Roth in order to make up for the taxes that need to be paid up-front at the conversion. In addition, investors need to decide on how they plan to pay taxes in the converted amount. Investors can pay taxes using the assets in the IRA or can use other assets available to pay the taxes. The amount an investor can convert from a traditional IRA to a Roth is unlimited. Be sure to discuss potential tax implications with your tax advisor before transferring assets. Converting to a Roth IRA can be a solid strategy to bring greater tax diversity to retirement savings.

When it comes to retirement savings and taxes, my clients often ask me if it's better to save on a tax deferred or after tax basis. Unfortunately, for those who prefer straightforward answers in life, what I tell them is not always the most satisfying -- BOTH. That's right. For many individuals, it's likely that each of the strategies has a role in their holistic plan. But it helps for clients to better understand the tax impacts associated with each of the retirement savings levers, so they know why and when they should pull them.

The third bucket of retirement savings taps after tax money through vehicles including money markets, mutual funds, brokerage accounts, stocks or bonds. As this money grows, interest and dividends must be paid annually. These savings can be withdrawn prior to turning 59½ without any penalty, offering more flexibility to anyone contemplating an early retirement or needing more flexibility with their money. Part of these savings, invested more conservatively, can also serve as a retiree's extra emergency fund to help pay for the unexpected.

Integrating two or three of these tax buckets into your retirement savings strategy can help improve your retirement readiness. Many different factors go into one's retirement readiness, including the tax strategy. Smart tax planning with your retirement savings can lead to a more comfortable lifestyle in retirement and greater financial flexibility.

* Contributions and any earnings are tax deferred and will be taxed when withdrawn, and may be subjected to an IRS 10 percent premature distribution penalty if taken prior to age 59½.

ING Retirement Coach Jacob Gold is a third generation financial advisor. He is a published author of "Financial Intelligence; Getting Back to Basics after an Economic Meltdown", which was published in August 2009. Gold is a CERTIFIED FINANCIAL PLANNER™ practitioner and Series 7, 24 and 66 securities registered.

Securities and Investment advisory services offered through ING Financial Partners, Member SIPC. Neither ING Financial Partners nor its representatives offer tax advice.

1. Tax Revenue Since 1950

10 Ways To Look At America's Low Taxes