As you’re transitioning to retirement, you may be in your highest income years and using your retirement contributions to lower your current income (and taxes) now. However, it can also be important to build out some buckets of retirement funds that can be withdrawn tax free in retirement. This may mean paying more in taxes now but will give you a lot more flexibility once you retire. Here are some strategies to consider.
1. Consider Roth accounts for potential tax-free income in retirement:
With a Roth IRA or Roth 401(k), you won’t receive a tax deduction when you contribute but can generally take withdrawals in retirement without paying taxes. You may benefit from a Roth IRA if you are currently in a lower tax bracket, expect to be in one of the top four federal tax brackets in retirement or have most of your investments in traditional IRAs or retirement plans and are looking to increase tax diversification and flexibility in retirement.
2. Utilize a health savings account (HSA) if available:
This is an account that has the rare ability to save you in taxes now and later. If it’s available to you, not only can it help you cover health care costs, but it can also be used as a savings tool for retirement. As health care is likely to be one of your largest expenses in retirement, HSA savings can help offset this expense and thereby help reduce the amount you withdraw from your other retirement accounts. Moreover, allowable contributions to an HSA are tax exempt, investment earnings grow tax deferred, and withdrawals from the account are tax-free if used for qualified medical expenses.
3. Backdoor Roth IRA strategies:
Some high earners make too much income to contribute directly to a Roth IRA. If this is the case, you might want to consider a “backdoor” Roth IRA. This isn’t a separate type of IRA but rather a strategy to gain the tax advantages offered by a Roth IRA. Ask your financial advisor if a backdoor Roth IRA fits within your financial strategy.
How you allocate your contributions across investment accounts will depend on your particular situation and may change over time. Your financial advisor can help design an appropriate retirement strategy for you. Also, you should consider working with a tax professional when evaluating tax benefits of a Roth versus a traditional IRA before making any decisions.
Edward Jones, its employees and financial advisors cannot provide tax or legal advice. You should consult your attorney or qualified tax advisor regarding your situation.