The retirement savings that you are working hard to build will one day become your retirement income. But have you considered the impact that taxes may have on your retirement goals? Given that tax rates on income, dividends and long-term capital gains are likely to increase beginning in 2013, now may be a good time to revisit taxes and your retirement strategy.
Roth IRA: Tax-Free Retirement Income
One approach to minimizing taxes in retirement is to maintain a tax-free account such as a Roth IRA. Rather than paying taxes when you withdraw the funds in retirement, you pay taxes on the funds when you contribute to a Roth IRA. If you think tax rates will increase or that you may be in a higher tax bracket during your later years, you may be better off paying taxes on your retirement savings now. A Roth IRA offers a number of tax benefits:
• Instead of getting a tax deduction when you contribute, you pay taxes on the contribution, but qualified distributions will be tax free.¹
• Earnings in a Roth IRA are not taxed, potentially enhancing growth of your account over the years.
• A Roth IRA is a smart solution if you expect to be taxed at a higher rate when you need withdrawals to fund annual living expenses.
Tax-Wise Tips With a Roth
When building a Roth account into your retirement strategy, there are three primary areas to consider: contributing to a Roth IRA, converting assets from a Traditional IRA to a Roth IRA, and contributing to a Roth 401(k) at work. One or more of these strategies may work for you.
• Contribute to a Roth IRA – In 2012, you can contribute $5,000 to an IRA – or $6,000 if you’re aged 50 or older. However, the IRS maintains income thresholds that determine eligibility for a Roth. For 2012, single taxpayers with income less than $125,000 and couples filing jointly with income less than $183,000 can contribute to a Roth IRA.
• Convert to a Roth IRA – If you are not eligible to contribute to a Roth IRA due to income restrictions, you can convert assets from a Traditional IRA to a Roth IRA. Roth conversions trigger a tax bill on investment earnings and contributions that qualified for a tax deduction. But if your contributions did not qualify for a tax deduction, investment earnings will be taxed but the amount of your contribution will not.
In addition, you can continue to build your tax-free retirement income each year by making nondeductible contributions to a Traditional IRA annually and immediately converting those contributions to a Roth IRA. Because you will have already paid taxes on contributions prior to conversion and growth should be minimal in such a short time frame, your tax liability should be minimal.
• Contribute or Convert to a Workplace Roth Plan if available - If your employer offers a Roth option in its 401(k), 403(b) or 457(b) plan, you can make nondeductible contributions on an after-tax basis. You can contribute up to $17,000 in 2012 – or up to $22,500 if you’re 50 or older. Also, if your employer’s plan allows it, you can convert pre-tax funds in the plan to the Roth option, if the plan contains a distribution option such as in-service withdrawal.
Unlike a traditional 401(k), where qualified withdrawals are taxed as ordinary income, qualified withdrawals from a Roth 401(k) are tax free. If you change jobs or retire, consider rolling over assets from a Roth 401(k) plan to a Roth IRA to continue the tax-free status of those funds. Review your plan document or check with your plan administrator to determine the rules associated with your plan.
Unless Congress intervenes, federal tax rates on income, long-term capital gains and qualified dividends will rise in 2013. This makes for a compelling reason to act now to create a tax-free source of retirement income. I can help you determine if a Roth is right for you and help you minimize the impact of taxes on your retirement income.
For more information, please call Brian P. Jacobs at 661-290-2022.
¹Restrictions, penalties and taxes may apply. Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted.
Articles are published for general informational purposes and are not an offer or a solicitation to sell or buy any securities or commodities. Any particular investment should be analyzed based on its terms and risks as they relate to your specific circumstances and objectives.
Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Smith Barney Financial Advisors do not provide tax or legal advice. This material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are urged to consult their personal tax or legal advisors to understand the tax and related consequences of any actions or investments described herein.
The appropriateness of a particular strategy will depend on an investor’s individual circumstances and objectives.
Article by Morgan Stanley Smith Barney LLC. Courtesy of your Morgan Stanley Smith Barney Financial Advisor. © 2012 Morgan Stanley Smith Barney LLC. Member SIPC.
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