Should we switch to Roth contributions before we retire?

Should you be making 401(k) or Roth IRA contributions?

In a perfect world, the answer would be both. If you have the means, maxing out traditional 401(k) and Roth contributions is a great way to build a diversified set of retirement savings. But of course your salary gets a vote. So if you have to choose, should you switch from contributing to a 401(k) to Roth 401(k) or Roth IRA contributions? The answer is… it depends on many factors.

Have questions about retirement planning? Talk to a financial advisor today.

Age and taxes are the most important factors

“The Roth IRA is the closest thing to a free lunch from Congress — the gift that actually keeps on giving over the long haul. But that’s why the sooner you take advantage of it, the better,” said Vijay Marolia, managing partner at Regal Point Capital.

In addition to tax rates, age is a critical issue when considering whether to switch to an after-tax account. The younger you are, the more this account will grow, and this can have even more of an impact since you’re paying taxes on contributions, not returns.

Here, at 50, you’re on the bubble. You’re not in the almost unambiguous range of, say, a 25-year-old investor, but you still have a few years left to save. The difference will come down to growth and taxes.

“Given your combined $1 million in 401(k) accounts, including the Roth IRA in your retirement strategy is wise. Planning for retirement and making smart investment choices are vital steps to ensuring long-term financial stability.” said Dutch Mendenhall, CEO of RAD Diversified.

But Mendenhall also cautions that it’s important to understand the rules surrounding different retirement options. Specifically, if you switch from traditional 401(k) contributions to a Roth 401(k) or Roth IRA, your taxes will increase. That’s because you’ll lose the tax deduction for your initial portfolio contributions, meaning you pay taxes on any money that goes into the Roth accounts. Now, this effect might be modest depending on the rest of the fiscal situation, but it should be considered.

Pay attention to contributions and income limits

Unless you only make modest contributions to your 401(k), which might be unlikely given a $1 million account balance, you may not be able to roll over entirely to a Roth IRA. The annual contribution limit for these accounts is only a percentage of that of a 401(k). Here’s a breakdown for 2024:

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In addition, the IRS sets income limits for who can participate in a Roth IRA. In 2024, a married couple can only contribute fully to a Roth IRA if they earn less than $230,000 a year and can’t contribute at all if they earn more than $240,000.

Consider talking to a financial advisor to build a retirement income plan.

Is this a good idea for your retirement plan?

“(The) main difference between Roth and traditional retirement plans is based on the timing and payment of income taxes. The variable that matters most when planning for the future is the estimate of your future income, or at least a basic estimate,” Marolia said.

Once you have that, you need to estimate your future tax rates. The lower the tax rates in retirement, the less value you’ll get from a Roth IRA because you’ll save less in taxes now. Instead, as Marolia says, “the Roth option is ideal for people who feel that their tax rates will be higher in the future and for those who believe that their income will continue to grow in the future.”

Essentially, with a Roth IRA you trade taxes today for no taxes tomorrow. This means that the longer you spend in retirement and the higher the tax bracket, the more value you will get from this account. On the other hand, the later you plan to retire and the lower your taxes in retirement compared to your taxes now, the less value you’ll get compared to the tax-deferred nature of a 401(k) or traditional IRA.

Retirement Planning Tips

• A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be difficult. The free SmartAsset tool matches you with up to three verified financial advisors serving your area, and you can have a free introductory call with your matched advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help reach your financial goals, get started now.

• If you have significant savings, it may mean that you also have significant income. In this case, the IRS may not allow you to make Roth contributions at all. Instead, you may want to consider a Roth IRA conversion.

• Keep an emergency fund handy in case you face unexpected expenses. An emergency fund should be liquid — in an account that isn’t exposed to significant fluctuations, such as the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But a high interest account allows you to earn compound interest. Compare savings accounts from these banks.

• Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with prospects and offers marketing automation solutions so you can spend more time converting. Learn more about SmartAsset AMP.

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