While most professional workers look forward to the day they’ll retire, some retirees dread it due to this reason: they don’t have a source of income to support their lives anymore. What’s worse, the savings they’ve built ever since they were young might be in danger of being drained due to their taxes. How can you make your retirement income tax-free? Here’s what the experts have to say.
Avail the Roth 401(k) Plan
Aside from your pre-existing retirement funds and accounts, the experts recommend you also get a Roth 401(k) plan. It allows you to make contributions even if your gross income goes beyond $137,000 (for a single individual) or $203,000 for married couples. It enables you to build your savings as much as you want unlike in Roth IRA where you’re subjected to a $6,000 annual contribution limit.
Try In-Plan Conversion
While most workers are tempted to withhold from paying their taxes to maximize their 401(k) savings, the experts say you might end up paying a huge tax bill later on. To prevent this from happening, they recommend you get a Roth 401(k) aside from the traditional 401(k) savings plan you have. Your Roth 401(k) plan allows you to tap its feature known as in-plan Roth conversion.
It means you can pay your taxes up-front every time you make contributions. It may result in lesser savings, but you’ll accumulate more funds in the long run since every earning won’t be subjected to pretax principals anymore. Aside from that, you can eliminate the chances of moving to a higher income tax bracket in case there’s a sharp spike in your accumulated salary contributions.
Know Your Retirement Plan’s Rules
It’s also essential you read the provisions of your retirement plan to know its rules and guidelines. For example, you may not be allowed to add more contributions to your Roth and traditional 401(k) accounts after you leave your employer, but you can still access the in-plan conversion feature to reduce your tax costs further.
You can do plan conversions as long as your retirement account permits it. Jana M. Steele at Callan’s Fund Consulting Group also warns the retirees against writing personal checks from your bank account and adding it as after-tax money to your savings plan. According to her, most retirement plans don’t allow a one-off contribution feature.
Find the Best Timing
According to financial experts, the biggest factor you need to consider in building your retirement plan is time. They say the best candidates to avail a Roth 401(k) plan or converting their pretax dollars are the millennials.
Since young professionals haven’t reached the full potential of their income yet, their Roth 401(k)’s contributions are slightly lower compared to workers who earn more. It enables them to pay lesser (or even tax-free) upfront taxes whenever they make contributions. Aside from that, their retirement funds can grow to its maximum potential over time.
Beware of Roth Conversion
If you’re retiring soon, the experts recommend you time in your Roth conversion carefully. Otherwise, you might end up wasting more money in the process. For example, if your in-plan conversion leads to an increase in your income, it might increase your Medicare premium contributions too.
Your payments for Medicare Part B and D (which covers your medical checkups and drug prescriptions) depend on your gross income two years before your retirement. New York’s renowned CPA Ed Slott recommends converting your Roth 401(k) plans at 62 years old if you plan to file for Medicare at the age of 65.
Another thing you should consider about Roth 401(k) conversion is that you’re subjected to mandatory withdrawals once you hit 70 years of age. So make sure not to commit the mistake of having last-minute Roth 401(k) conversions. According to Slott, you may opt to convert your Roth 401(k) plan to Roth IRA to avoid these required minimum distributions.