A 401(k) Saver with Multiple Accounts Considers Options

Q. My employer now offers a Roth 401(k) and a regular 401(k). I have 80 percent of my assets in accounts that will be taxable when I retire (regular 401(k) and IRAs) and 20 percent in Roth IRAs. I’m thinking of changing 100 percent of my 401(k) contributions to the Roth 401(k) so I have options when I retire, for example, being able to choose the withdrawal of taxable money versus tax-free money. Is that a smart strategy, or am I missing something?
—More than one 401(k)

A. Smart question, and smart thinking.

Roth 401(k) plans allow the same contribution levels as traditional 401(k)s, but rather than investing pre-tax dollars – which means an income tax cut today – you’d invest after-tax money in Roth accounts. Those funds are tax-free upon retirement.

Saving pre-tax dollars in a traditional 401(k) used to be a no-brainer, said Brian Power, a certified financial planner with Gateway Advisory in Westfield. The idea was that you’d be in a lower tax bracket when you retire, so you’d pay less in taxes overall.

"With our country being in such a financial mess, there is a good chance that income tax rates could go higher after 2012 to help balance our country’s budget," Power said. "This could mean that a person’s income tax bracket may not be lower and in fact could be higher [in retirement]."

Power agrees with your thinking that having tax diversified income options in retirement makes a lot of sense. This would be no different than advising someone "not to have all their eggs in one basket" with investments, he said.

Brian Kazanchy, a certified financial planner with RegentAtlantic Capital in Morristown, agrees, saying your current mix is a good start, and obtaining more Roth retirement savings may be wise.

Before making your final decision, you need to consider your personal tax rate, he said.

"Traditional retirement plans allow you to contribute funds to the plan without paying tax on that income in the current year," he said. "When contributing to a Roth retirement plan, you pay tax on the income received in the current year."

If you suspect your current tax rates are significantly higher than the tax rates you will pay in retirement, the current tax savings from a traditional retirement plan will provide an advantage over the Roth.

"Unfortunately, it is virtually impossible for anyone to know with confidence what tax rates will be in the future," Kazanchy said.

While tax rates matter, the most important drivers of success in using a Roth retirement plan versus a traditional retirement plan is your investment strategy and your time horizon. When assets are placed in a Roth retirement plan, the funds grow tax-free until distributed. If you can push off distributions from your Roth account as long as possible, there will be more time for tax-free growth, Kazanchy said.

The investors who derive the greatest benefit from a Roth retirement account are individuals who are successful in achieving significant growth in those assets. Kazanchy said a Roth account should be filled with the investments that have the most growth potential, or a higher rate of return, as long as those investments fit in with your overall asset allocation plan.

Source: http://www.nj.com/business/index.ssf/2011/11/a_401k_saver_with_multiple_acc.html