Tim Regan (0:09)
Hi, and welcome to this episode of the Retirement Readiness podcast. Lately, we’ve been around town and you’ve seen us at different locations. Today, we’re back here in our office in Orland Park, Illinois. Joining me, as usual, is my co-host, Katie Umland. And today, Katie, we’re going to talk a little bit about, “Should I look at contributing to my regular 401k, traditional IRA type things? Or should I really be looking at doing maybe a Roth contribution?”
Katie Umland (0:36)
So we’re back to topics that I don’t quite understand, but you do.
Tim Regan (0:40)
Yeah, for sure. At least for this episode, the days of me walking on the treadmill at Orangetheory are coming to a close. So let’s talk a little bit about “What is a Roth IRA versus a regular IRA?” “What’s the 401k?” You know, “How does all that work?” And then ultimately, “How should I be saving into those, but then how does that mean, I withdraw when I hit retirement age, and, you know, how do I build my income from there?” Though, in your case, what’s your understanding of Traditional versus Roth and all that kind of stuff?
Katie Umland (1:21)
So I think that Traditional and Roth are different based on how you’re taxed, depending on when you put it in versus when you take it out.
Tim Regan (1:32)
Katie Umland (1:33)
One, I think traditional, you’re taxed when you take it out.
Tim Regan (1:36)
Katie Umland (1:37)
And Roth, you’re taxed when you…
Tim Regan (1:39)
…Put it in! Yep, absolutely. So what happens is, like, if you think about your regular 401k, or a traditional IRA, the reason people put money into those when they’re working, is because the money that they put in, they don’t pay tax on when it goes in. It grows tax-deferred. But then whenever they take the money out, they have to pay tax on whatever comes out. With a Roth, to the extent that you’re saying, you pay tax on it now, but when the money goes in, it grows tax-deferred, it’s never taxed again. So sometimes the reason people look and say, “I want to put it in and not pay tax now,” is because they’re thinking that their income is going to be higher when they’re working. And then when they hit retirement age, when they take it out, income would be lower, which means they might save some money.
Katie Umland (2:25)
It’s reminding me of when you file your yearly taxes, like some people like to pay as they go, like, have more taken out of their paychecks every month, and then hopefully get a little bit back at tax time. And some people prefer to, like, not really have much taken out and then see where that winds up.
Tim Regan (2:43)
Yeah, so it is similar like that. And really what it is, is people looking to see “Where will I pay the least amount of tax? Do I think I’m gonna pay more in tax now? Or do I think I’ll pay more in tax when I’m in retirement?” The funny thing is, you know, like we’ve talked in other episodes, a lot of people think, “When I’m working, I’m going to be in a higher income bracket.” But kind of like we’ve talked before, when do people spend the most money? It’s on the weekends, and when they retire, everyday is the weekend, right? So a lot of times, the thought that your income comes down in retirement really isn’t reality, because you don’t retire thinking “I want to do nothing.” You retire thinking, “I’ve got this list of things I want to do,” and you end up spending almost more money. And so, a lot of times when people sit down to make those decisions, and as we talk with clients, it really is a conversation around, partially, where we think tax rates are going. But it’s even more than that. It’s a conversation on diversification. So if I said to you today, “Hey, let’s take all of your money and put it into one stock.” Is that a good idea?
Katie Umland (3:53)
No. Really risky!
Tim Regan (3:54)
Yeah, for sure. Right. The same. You should be diversified. And so one thing that we start to talk about is “How do you diversify your portfolio from a tax perspective?” And what we found is we have a lot of our clients that, for years, have been saving into their 401ks, and so they have a lot of money that’s built up in these tax-deferred vehicles, then they get to retirement age, and what happens? Every dollar they take out, they have to pay income tax on it. So they have no tax diversification. So, one way you can diversify from a tax perspective, is let’s have some money go into a Roth IRA, that now when you get to retirement age is tax-free. So you have an option for “Where do I get money?” You know, I was thinking about, even with you and Alex, and we’ve talked about the lake house before in a previous episode. And so when you guys think about retirement, and you get to that point, and you need a new pontoon to have all of your money tied up inside of a 401k, you’re gonna have to pay tax on it when it comes out. How much do you have to take out to pay the tax to get enough to buy the pontoon, and then what does that do to your tax bracket? And so, a lot of times, what we’ll do is we’ll talk to clients about having some of that Roth money. Is that large purchase…
Katie Umland (5:15)
Tim Regan (5:16)
Yeah, for sure. You can look at it that way. One of the reasons why a lot of times will tell clients to have money inside of their Roth account, this time of year, right, think about it, too. As you’re in retirement, we were just talking as an office about over Christmas shopping, right? And that’s, I think, kind of one of the things you enjoy doing.
Katie Umland (5:36)
Anytime shopping. I’m not limited to just Christmas. Yeah.
Tim Regan (5:40)
So, when you have kids, and you’re at Christmas time, a lot of times clients think about making gifts to their children. And so as they do that, sometimes we have clients that say, “Let’s take a big trip at Christmas time,” or, you know, those are kind of larger expenditures. And sometimes having the flexibility to take money out of a tax-free vehicle versus having to always pay tax on it is helpful. So those are some of the reasons why you would choose to put money into a Roth. And then some of the other things we look at… Have you ever heard of minimum distributions?
Katie Umland (6:15)
Just overhearing it in the office.
Tim Regan (6:19)
What’s your understanding with those? Or do you have any thoughts on that?
Katie Umland (6:23)
So I think the government makes you take out a certain amount each year because they want to tax you on it?
Tim Regan (6:33)
Katie Umland (6:34)
So there’s a minimum amount that you have to take out so that they can collect tax.
Tim Regan (6:39)
100%. What happens there is when you turn age 72, right, now they’re talking about maybe moving that age 75. But when you turn age 72, you have to start taking money out of your 401k, your traditional IRA, that kind of stuff. And so what happens is, we can have clients that are fortunate enough that they don’t really need all of that minimum distribution money. Their other income sources are enough to support their lifestyle. And now, all of a sudden, when they hit age 72, and they have to start taking all that money out, that has the potential to move them into a higher tax bracket, they’re paying a higher cost to get those funds out. But they have no choice. They have to take it out. Versus like a Roth IRA. Inside of that Roth, you don’t have those minimum distribution requirements. And so that when you can just sit there and continue to grow, if you don’t need, obviously, you can take off if you want to, but it can continue to grow, which then, ultimately, is tax-free for the kids, too. So, you know, as we sit down with clients, and really start looking at, “Should you want to do a Roth IRA, or should you have money into your traditional?” What we encourage is, “Let’s sit down and let’s be really intentional about what those percentages look like.” How much do you have in a Roth? How much do you have in a traditional? Your current contributions going into your 401k – Should they be in a Roth, or should they be going into the tax-deferred portion of that 401k? And what we find is that really, it can mean a pretty significant change to the flexibility that they have when clients are retired. So one of the things from from our perspective, if you kind of go down, we’re getting close to the end of the year. And so you start thinking about checklists or New Year’s resolutions, or what should I do or you know, all that kind of stuff. And one of the things that we would encourage is that on that checklist of what am I going to do in the new year, is looking at what those contribution rates are inside of the 401k. Do some analysis around “Should I be moving some money into a Roth contribution versus the traditional 401k?” But also, you know, let’s set up a plan for Roth conversions. We talked about that in a previous episode. And it’s a great time right now, with where tax rates are to even think about “Should I be building that Roth in a bigger way, by taking money out of that traditional IRA, converting it into a Roth IRA?” And right now, the reason we like to think about that this time of year. First, if there’s any last minute things you want to do, now’s a great time to really get those done. Secondly, though, it is kind of that, “As I turn the calendar, and start thinking about what I’m going to do differently in 2023,” that’s a great place to start. And it is a very simple, easy to change thing if you want to make changes. So just something to keep in mind.
Katie Umland (9:32)
If your employer offers matching or any kind of help with that, is that something that a client could bring into you, like, kind of their their 401k package at work, and you could help them look through that and help them determine where would they would fall?
Tim Regan (9:50)
Yeah. Our role would be to sit down and help you determine how much you’re going to Roth versus how much you’re going to traditional, what does that maybe look like long term, how does that help me from a flexibility perspective and all that kind of stuff. So yes, that’s part of our role. Now, obviously, we don’t know what tax rates are going to be in the future. But we can help give you an educated estimate there. But beyond that, to explain how it works, because it’s always the same. So if your employer offers matching contributions, or any sort of contribution into your 401k, regardless of what your choice is, their contributions always go into the tax-deferred part of your 401k. There’s some conversation now. In legislation right now, they’re talking about allowing for you to choose that it goes to the Roth versus not, but the way the law is right now, any employer contributions go into that tax-deferred portion, which would be traditional. And so, a lot of times when we work with clients, we look and say, “Well, if you’re already getting company match into the traditional, maybe it makes sense to start building Roth contributions.” And the big part there, too, is especially when you think about how those 401k’s are allocated and managed, we’ve seen an entire shift in the industry, to where employers are kind of putting clients into what we call “target date funds” or “retirement date funds.” And what those are is their vehicles that are kind of… you sell and retire in the year 2025 and they get more conservative as you get closer and kind of change for you. Which is great. It’s a great way to kind of set it forget it. But as clients start wanting to be more intentional managing those assets, sometimes it makes even more sense to say, “Let’s not only look at is Roth contribution versus traditional the right thing,” but it’s also you know, “Are those assets actively managed and all that kind of stuff?” So yeah, our suggestion would be one of the things to do here, turn of the year, check out not only “Am I putting the right amount, the right percentages into the 401k? Am I doing any catch up contributions?” Those things. But even beyond that, “Should I be doing Roth contributions or traditional stuff?” So thank you for joining us on this episode, where we talked about Roth versus traditional types of retirement accounts. Look forward to next episodes where we’ll be talking to our friends at Smith Crossing, and, hopefully, you have a very blessed Christmas and New Year season if we don’t talk to you.
Katie Umland (12:30)
Thanks so much. And if you found any of this valuable, like and subscribe to our YouTube channel
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