section 1 - The American College Online Learning Center

(1) If eligible, planners should recommend that clients make contributions toa Roth IRA.(2) Make a Roth election with regard to salary deferrals in anemployer-sponsored savings plan.(3) Self-employed person can establish their own 401(k) plan that has a Rothelection.(4) Convert IRAs (or qualified plan benefits) into a Roth IRA.c. Plans that provide for tax-deferred earnings3. Tax advantages(1) Make nondeductible contributions to an IRA.(2) Purchase a nonqualified annuity.(3) Make after-tax contributions to qualified plans.a. Compare saving on a pretax (tax deductible) basis versus saving on an after-tax(taxable) basis(1) Example: Jennifer is age 30; she wants to save $3,000 a year (pretax)until she retires at age 65, she will earn an 8% return, and she will betaxed at a 25% rate. Compare saving $3,000 each year to saving $2,250on an after-tax basis.(2) Jennifer accumulates approximately $86,000 4 more saving pretaxassuming that at age 65 all tax-deferred amounts are distributed and taxedat a 25 percent rate. In the calculation there is also the assumption thatafter-tax earnings are subject to income tax each year as ordinary income(as would be the case with bond investments).(3) The value of saving on a pretax basis increases as the individual’s taxrate increases.(4) Example: Take the Jennifer example, but now assume a 35% tax rate.Now the difference between pretax and post-tax saving is approximately$97,000.(5) If tax rates increase in the future, saving on a pretax basis has somewhatless value. The result will depend upon the number of years of tax deferral,the future tax rate and the rate of return.(6) Example: Assume that in Jennifer’s example the 25% tax rate changes atage 65 to 35%. Now the difference between pretax and post-tax saving isa lower amount, approximately $52,000.(7) Example: Change the example again and assume that Jennifer only savesfrom age 60 to age 65—and the tax rate changes at age 65. Here, withthe short deferral period, Jennifer would actually be better off saving on apost-tax basis.(8) Planning Point: The decision about where to save takes on greaterimportance if tax rates shift dramatically.(9) Planning Point: The decision about where to save takes on greaterimportance with regard to the amount of time the savings remain in theaccount.4. Calculated using the “IRA Savings Calculator for Tax Deferral Comparison” at the website “Free-Online-Calculator-Use.com”.3.8