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Nov. 23, 2021, 7:10 p.m. EST

Should I use a 401(k) or an IRA to save for retirement? A traditional account or the Roth version? Here’s what to know

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By Alessandra Malito

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Finally, you could decide to have a mix of traditional and Roth accounts so that you have more flexibility with your withdrawal strategy. For example, if your tax rate is higher than usual in one year in retirement, you could withdraw money from the Roth account rather than having to pay taxes on the traditional account. Just don’t forget the required minimum distributions!

When can I take out the money?

With a traditional 401(k) or IRA, you pay taxes at your income-tax rate when you take out money. As mentioned, there’s that 10% penalty if you do it before you are 59 ½ years old. There are some exceptions, such as costs for higher education or unreimbursed medical expenses not covered by insurance as well as under the rule of 55 .

But remember, this is retirement money. Let it grow. Time is your biggest ally.

Read: To get rich investing, the power of time beats a lucky stock pick

Still, you can’t keep the money there forever. You must start taking out money from a traditional IRA, a traditional 401(k) and a Roth 401(k) at age 72 under what’s known as a required minimum distribution. Only Roth IRAs are exempt from this rule.

Can I change my investments?

Yes.

You can do this at any time. It can be for fresh money, money you’ve already invested or both.

So what’s this about a backdoor Roth?

This is when you move money from a traditional IRA to a Roth IRA, paying taxes now in a bet that it will be less than what you’d pay later.

Congress is discussing whether to eliminate this option , so don’t count on it forever.

Whether a Roth conversion (also called a backdoor Roth) actually saves on taxes over the long run is up for debate. One study , entitled “When and for Whom Are Roth Conversions Most Beneficial?”, argued participants are most likely to see a return on this conversion if they have decades of uninterrupted growth in their accounts as well as the ability to make a conversion at the 0% tax bracket.

“Otherwise you fail the conventional test that requires the tax level in retirement to be higher than the tax level on the conversion,” wrote the report’s author, Edward F. McQuarrie, professor emeritus at Santa Clara University. “Put another way: unless both members of a 60-something couple are 401(k) millionaires, their tax rate in retirement will likely be 12%.” 

(In 2021, the 12% tax rate for a couple married filing jointly equates to an adjusted gross income of up to roughly $81,000). 

Read Brett Arends: Why I won’t do a Roth IRA conversion—even if this is the last chance

Remember those rules about required minimum distributions, also known as RMDs? For people with millions of dollars in their traditional IRAs (that includes those who rolled over their 401(k) balances into an IRA upon retirement), those withdrawals likely would push them into higher tax brackets. But money in a Roth IRA isn’t covered by those rules.

Those with less money in a traditional IRA will likely already be in low tax brackets in retirement, possibly at a rate even lower than when they converted the funds from a traditional to a Roth account. That makes any Roth conversion unhelpful. 

When it does benefit most taxpayers, according to this study, is when account holders live past age 90. That’s because the money grows tax-free and needs a long, undisturbed period to compound. 

Here’s how a backdoor Roth works: If, for example, you had a traditional IRA with $300,000 and wanted to convert $50,000 of it to a Roth in one year, you would only pay taxes on that portion. There’s no limit on the amount you can convert in any year or how many times you can use this technique.

But there’s a wrinkle to it. While you won’t have to pay any early-withdrawal penalties, the extra $50,000 in income could bump up your tax bracket. You may want to consult a tax professional on both timing and help in calculating the tax bill. 

Still, some Americans see conversions as a way to protect themselves against unknown higher tax brackets. Some savers assume the Biden administration will raise taxes and are using Roth conversions to shield themselves from these higher tax brackets in the future, regardless of their current tax rate. 

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