section 1 - The American College Online Learning Center

a. Example:(1) Save $10,000 in 25% tax bracket(2) Pretax save $10,000, pay taxes on earnings(3) Tax-exempt save $7,500, earnings tax exempt3. How tax rates affect the decision to elect Roth vs. before-tax saving (Video: Howcurrent and future tax rates affect the choice of retirement vehicles? Littell, Nanigian,Reichenstein)a. There are a number of ways to access both types of tax treatment.b. Example: Assume a 35% tax bracket now and 25% tax bracket in retirement. Let’scompare a $10,000 401(k) salary deferral to a $6,500 Roth 401(k) election—bothreduce the amount you can spend this year by $6,500. Assume 100% rate ofreturn with either choice. The $10,000 401(k) grows to $20,000 and becomes$15,000 after-tax (25% rate in retirement). This is essentially growth from $6,500to $15,000. If $6,500 went to the Roth, it grows to $13,000 in retirement.c. Choose tax deferral if the tax rate is lower in retirement.d. If higher tax rate in retirement then choose the Roth.e. If tax rates currently and in the future remain the same—accumulation is thesame, but other factors below, may lean toward the Roth4. Estimating tax rates in the futurea. Young people are often in a low tax bracket and should strongly consider the Roth401(k) rather than the tax-deferred 401(k).b. If a client is temporarily in a low tax bracket, they should strongly consider theRoth 401(k) rather than the tax-deferred 401(k).c. Those in the top tax bracket may expect future rates to be higher.d. Middle income are likely to be in the same or lower bracket(1) With elimination of deductions for qualified plans and mortgage interest,this may not be true.(2) Beneficiaries (widow, adult children, trust) may be in a higher tax bracket.5. Other reasons a client should consider a Roth vehiclea. A Roth allows the client to save more. For an individual in the 35% tax bracket, a$22,500 Roth 401(k) contribution is effectively a larger contribution than a $22,500pretax salary deferral (which only reduces current income by $14,625 and onlyresults in $14,625 of after-tax retirement income).b. Can be saved for use later in retirement (no required distributions) and/or efficientasset to leave to heirsc. Roth vehicles have no required minimum distribution so they can be saved as ahedge against longevity.d. Roth IRAs are more tax efficient for heirs.e. Tax diversification(1) Can do income tax bracket planning(2) Roth distributions are not counted for Social Security taxation.(3) Roth distributions are not counted for determining Medicare premiums(Medicare premiums are based on income).6. Roth Conversion issues (Video: How do you execute a Roth IRA Recharacterizationand/or Reconversion? Littell, Schneider)a. Convert when tax rates are low.3.15