Making Sure Your Family Is Okay

Whether you're just starting out on the road to retirement savings or are looking for a checkup along the way, you may be concerned about the impact of future taxes on your nest egg. And with the news constantly reporting on topics like Social Security being in trouble and pensions quickly dying out in the workforce, you're likely looking toward your private retirement savings to provide your sole financial support after you've stopped working. Read on to learn more about the impact of tax changes on your retirement accounts.

What effect do tax rates have on your retirement accounts?

Most workers have access to several different types of retirement savings accounts -- tax-advantaged, taxable, and tax-deferred. Although the dollar amounts you can place in each type of account can vary based on your type of employment (employee or self-employed) or your total household income, you'll generally have some way to get at least a little money into each of these "buckets." The tax treatment of these funds can dramatically impact the amount of money you have at your disposal.

• Tax-advantaged funds are held out from your income before taxes are assessed -- like 401(k) contributions. This can provide you with two advantages. First, you're able to save current tax money on the amount withheld, so you can lower your total taxable income and put more money back into your pocket. You'll also be able to later sell these funds and pay only the capital gains rate, rather than your highest marginal tax rate.
• Taxable accounts are funded with already-taxed money and are subject to capital gains taxes at the time they are withdrawn. However, there are generally no limits on the amount of money you're permitted to put into a taxable account, so this can be a good investment option if your income prevents you from taking advantage of some other retirement accounts.
• Tax-deferred accounts, like IRAs, simply put off your payment of taxes until later. You'll be able to deduct your contributions on your income taxes for the contribution year, lowering your taxable income by that amount. Later, when you sell off the IRA, you'll be required to pay taxes on the liquidated amount at your future tax rate. This means that if you're in a high tax bracket while you put the money aside and in a low tax bracket when you withdraw it, you'll pay fewer taxes than if you had saved that money in another type of account.
• Post-tax accounts, like Roth IRAs, allow you to pay your current marginal tax rate on the money saved and then withdraw this money -- plus all earnings -- completely tax-free in retirement. These can provide great advantages for those who are currently in a low tax bracket (or owe negative taxes) but expect their income to increase and put them in a higher tax bracket in retirement.

What are the best options for minimizing taxes in retirement under the current tax code?

The current U.S. tax code is a progressive one -- the lower levels of income are exempt from certain taxes, while income in higher brackets is taxed at a higher rate. This means that it will likely be to your advantage, both now and in the future, to spread out your retirement allocations into a variety of accounts. If you're in a low income bracket now, you might want to start with a Roth to take advantage of your low tax rate and a 401(k) to further minimize the amount of money on which you pay tax. In the future, you'll be able to phase back your Roth contributions as you increase your tax-advantaged or tax-deferred contributions.

By spreading out your contributions into a variety of accounts, you can give yourself flexibility in the future. For example, you may want to minimize your future tax rates by withdrawing tax-advantaged or tax-deferred funds only up to the amount of your exemption (making these funds tax free) and then filling the rest of your income needs by withdrawing from a tax-free account, like a Roth IRA or Health Savings Account (HSA) for qualified medical expenses. Talk to a private wealth management professional for more information.