How to Accumulate Retirement Assets Tax-Free
- Why it’s important to evaluate how much money you have in tax-deferred accounts
- Why Roth accounts are a valuable alternative
- Income level restrictions on who can contribute to a Roth account
- How much eligible professors can contribute to a Roth account this year
Most people do not object to paying taxes. But at the same time, nobody wants to pay more than their fair share. This is a great time to review your financial assets from an expense-reduction perspective. One way to improve the net return of a portfolio is to reduce overall taxes on your investments. Here is where to start.
For many years now, university professionals have enjoyed the benefits of tax-deferred, mandatory retirement plans provided by their employers. As a result, many university professionals have substantial amounts of their retirement savings within these plans. In addition, all universities offer supplemental, voluntary payroll-deduction plans to which an employee can contribute additional tax-deferred deposits. These voluntary tax-deferred accounts, when combined with the mandatory tax-deferred accounts, should be evaluated as a whole because of the changing trend in income tax rates. Here’s why.
It made sense to defer a portion of your salary when marginal income tax rates were at 70 percent. Funds could then be distributed at a later date when tax rates became much lower. But going forward, when income tax rates increase, it does not make sense to defer income at a lower rate, then withdraw funds at a much higher tax rate. (Income tax rates are likely to increase in 2025, when many of the provisions of the 2017 Tax and Jobs Act expire, if not sooner.)
In addition, having too much of your assets under the shadow of deferred income taxes can be a huge trap at the time of distribution. For example, if all of a retiree’s assets are held in income-tax-deferred accounts, and the retiree needs more income in a given year than had been originally anticipated, the larger distribution will cause a higher tax to be incurred. It is wiser to have some assets in “after-tax” accounts or “tax-free” accounts to be accessed in case of a financial emergency.
The good news is that you can control the tax “structure” into which deposits are made now. For example, instead of putting all retirement plan deposits into income-tax-deferred assets, you can balance your situation by using other tax structures that are available for after-tax deposits now.
Here is the good news. There is a whole tax structure that allows for investments to grow “income-tax free” and capital gains free; they are called Roth accounts. Roth accounts can be a very valuable alternative for university professionals. Many are unaware this option is available to them.
A Roth IRA works in exactly the opposite manner of a traditional IRA. You have to pay taxes before you make your contributions. However, when you pull out the earnings and principal at retirement, you are not taxed on any of the withdrawals.
After its inception, the Roth IRA gained immediate attention and acclaim. Imagine being able to pay taxes up front and then never having to pay taxes on any of the growth in the account. For most individuals it seemed too good to be true, and for many it was. The Roth IRA came with specific earning limits which restricted people of certain income levels from making contributions.
The limits have changed over time, but currently a single person earning more than $135,000 or a couple earning more than $199,000 is prohibited from making contributions to a Roth IRA. However, today there is another way to establish a Roth account and benefit from tax-free growth without being subject to the income limitation just mentioned.
Roth Payroll Deduction Account
Many university professionals can now have access to the tax-free growth of a Roth account through their university benefits plans. Many universities have established payroll-deduction Roth 403(b) plans. The contributions to these funds are made after income tax has been taken. However, the interest and appreciation grow tax free. In addition, the funds can be distributed at a later date income-tax free. In other words, once an after-tax deposit is made, the investment will grow and distributions will be tax-free.
And there’s more good news. The amount that a participant can contribute to these new payroll-deduction Roth plans can be as much as $24,500 per year if you are age 50 or older. Unfortunately not every university has established the payroll-deduction Roth plan. Be sure to ask your benefits office about this great way to save tax-free. There is no income limitation in the payroll-deduction plans as there is with Roth IRAs.
This Is the Year to Take Action
This is a great time to review the benefits of tax-free Roth accounts. Roth accounts will help reduce future tax expense and provide more flexibility and control over your retirement plan assets at the time of distribution.
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