The recent political flap over 401k plans should get you thinking

How you save for retirement can be as important as how much you save. 

Should you save for retirement using only the pre-tax contributions in your 401k plan (or IRA for that matter)?

The answer is not simple and you have to take a long-term view because the implications extend into retirement. However, my quick response is no, you should also assure some investment withdrawals in retirement are tax-free and can be timed by you, not the IRS. 

First, regardless of pre or post-tax contributions, always contribute so that you receive the maximum possible employer match. 

Second, always contribute the absolute maximum you can and start as early as possible and never stop. 

Now, think about how to save. 

If you are a relatively low income earner today, it may be better to save after-tax now in return for tax-free income later when you may be in a higher income bracket. This means a Roth 401k if available or a Roth IRA. 

Keep in mind too that earnings on traditional 401k (and IRA) contributions are taxed later as ordinary income, not as investment income like capital gains and dividends. So you get to keep less. (This is also why I suggest some savings outside any qualified retirement vehicle … perhaps high quality dividend paying stocks or mutual funds.)

401k balances, pre-tax or Roth, are subject to the required minimum distribution at 70-1/2 while Roth IRA money is not subject to RMDs. 

What you can do: 

Roll over a traditional 401(k) into a traditional IRA, tax-free.

Roll over a Roth 401(k) into a Roth IRA tax-free thereby avoiding the required minimum distributions on that money. 

Roll over a traditional 401(k) into a Roth IRA—this would be considered a “Roth conversion,” so you’d owe taxes.

Here are the complete IRS Required Minimum Distribution Rules to review. 

Statements like the following are common and readily accepted by many people, but can be misleading. Earnings on your IRA or 401k are not taxed as they accrue, but do not accrue tax-free, they accrue tax-deferred. Only earnings on a Roth account are truly tax-free. The valid point however, is that if you are not paying taxes as earnings accrue there are more earnings to compound over time. 

Compound interest is your friend — we hear it time and time again, so if you can start saving earlier, your portfolio will have more chance to recover from market shocks and also earn more in interest. If your money is in a retirement account like an IRA or 401(k), those earnings accrue tax-free. In a Roth IRA, the money you put in is taxed upfront, so any earned income accrues tax-free and will also be tax-free when you take distributions after age 59½.  Source: CBSNews


  1. One of the things that the Internet has done is to make investing so much easier and cheaper. I once had 7 shares from a LOSOP conversion that I could not get rid of because I had to go to a broker and their fees wiped out all the profit for the stock (in the 1990’s). It took me 15 years before I got rid of those seven shares.

    I am in a 401K because I needed the tax deferral in order to save what little I could at the time. I had no idea that I would make six figures later in my career when I just started out in my 20’s. Decades later when I realized that I might end up with a retirement over $100K, I figured I would have to deal with those issues then.

    Well, then is now and as it turns out that in 2018 you have to have an ADJUSTED income over $77,400 to jump from a 15% tax bracket to a 25% tax bracket. With the personal exemptions of ($4150 per person, $8,300 married) and the standard deduction (for a married couple if you do not itemize) of $13,000, your GROSS income would have to above $98,700 before you start paying 25% on everything above that $77,400 (adj) income. It turns out that I’ll be safety in that 15% bracket for several years and then I will just cross over when I start collecting social security unless I take giant withdraws from my 401K.

    My point here is that although income tax liability at retirement should be considered in which plan to get into if given a choice, it should not be a concern unless you are making 6 figures fresh out of school. Tax confusion is no excuse not to save. The reality is that for the bottom 90% of wage earners, they will pay less than 15% in income taxes on their retirement income, if any tax. People just need to save, save, save while young and let the compounding help their retirements.

    Paying off your debt should be stressed more than which tax bracket you might end up in. Paying a few hundred dollars in extra taxes does not justify not saving tens of thousands of dollars for retirement.


  2. .

    Before I retired early, I made sure I was totally out of debt, including my house. Since I live in a less expensive part of the country, for the past 10 years in retirement I have lived comfortably on a low income. My retirement nest egg has grown during those 10 years. Because I have no income besides SS, I have been able to take out several thousands of dollars each year from my traditional IRA tax-free [making sure I stay under the IRS tax threshold.] I plan to keep doing that until I am required to take out government mandatory distributions. If I am blessed, at that time in the future, those yearly mandatory traditional IRA distributions may also be at least partially under the IRS tax threshold [ie, tax-free.]



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