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Are Traditional 401(k) Accounts Bad For Your Retirement Dreams?

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Are Traditional 401(k) Accounts Bad For Your Retirement Dreams?

If your retirement account is in a traditional 401(k), you might want to consider switching to a Roth IRA, according to personal finance guru Suze Orman.

The reason, says Orman, is the idea that you will be withdrawing funds from your 401(k) in retirement when your personal tax rate is lower than it is today is likely not going to be true.

The amount of debt the country is carrying means tax rates in the future are going to be higher than they are today, not lower.

With a traditional 401(k) account, you put your money in “pre-tax” today and let it grow tax-deferred until you start your withdrawals. Those withdrawals will be at whatever the future tax rate is, which Orman says will be higher than today.

With a Roth IRA, you put in “after-tax” money today, but because you already paid taxes, your withdrawals are tax-free.

Why Switch?

“The main thing really is this… please, if you have the ability to do a Roth 401(k), 403(b) or TSP, or a Roth IRA, those are the type of retirement accounts you want to be in,” says Orman. “Stay away from the “traditional” ones, that’s what they are called “traditional” IRAs or 401(k)’s, where you get a tax write-off today, but in the long run when you go to take your money out, you’re going to have to pay taxes on it. A Roth, you pay taxes today, and in the long run when you take it out, it’s tax free.”

Orman says the government can see all the money sitting in individual retirement accounts and knows when the tax-deferred accounts will need to take required minimum distributions, the first time the government will get their chance to tax the money.

“Do you really think that tax brackets aren’t going to have to go up 5, 10, 15-years from now in order to pay for all the debt we are carrying? Of course they are going to have to. When you put money in a retirement account, the government knows exactly how much money you have in there. The government knows you have to start taking required minimum distributions out by the time you are 72,” says Orman.

She suggests we just bite the bullet today and fill our accounts with “after-tax” money so we don’t have to worry about rising tax rates in the future.

“So given everybody’s going to get there soon rather than later, I’m telling you, I would rather pay the taxes today when we’re in the lowest tax brackets of a long time still, and let the money grow tax-free versus tax-deferred.”

Financial Advisers Agree

Mark Beaver, a financial adviser at Keeler and Nadler, agrees with Orman’s preference for a Roth IRA over a traditional 401(k).

As per Market Watch, “Orman is right in that these tax rates are a deal right now. ‘The tax code today is about as favorable as it’s ever been and the likelihood of that changing (to be higher) in the future is pretty good … Because of that, we look to add to Roths directly or do things like backdoor Roth contributions or conversions where it makes sense.’”

Monica Dwyer, vice president at Harvest Financial Advisors, warns that the government can also change the rules at any time about how it taxes retirement accounts, so today’s benefits of a Roth IRA could disappear in the future.

“Congress can get pretty creative about where they are going to collect taxes from and there is no guarantee that they won’t someday go after Roths,” she said.

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