Should I hold off on investing income within my Roth IRA due to Trump's desire to lower taxes?
Since Roth IRAs are funded with after-tax dollars, should I factor in Trump's inclination to lower taxes to decide whether to keep investing inside my Roth IRA? If the lowering of taxes is indeed inevitable, wouldn't I be better off contributing my income to a pre-tax retirement account, at least until taxes are lowered?
That is a great question. Very few people actually do the math. If you assume the same tax rate, the amounts are actually the same. I like to have a mix of accounts for this very concern and for flexibility, but if I had to pick without more detail, I like the Roth.
If our national debt was zero and we did not have so many baby boomers using Medicare and Social Security, I might agree with you a little more, but a president only serves for 4 years (I am not making a political statement) and unless you are in your 60's, the accounts are most likely for the long term.
If you open an IRA now, you will have a tax deduction and in theory, could invest those savings, but few do. You also have indirect factors to look at like, RMDs -- required minimum distributions. This forces you to pay the taxes in retirement. With the Roth, you can just leave it alone and pass it on to your kids. The increase in adjusted gross income (AGI) could affect other tax-related things, like the Medicare surtax, costing your more in taxes.
So, this is very client specific and you are making an educated guess at the future, but unless you are close to retirement, I would error on the side of the Roth.
Mark Struthers CFA, CFP®
Have you heard the phrase “Don’t let the tax tail wag the dog?” It’s good to proactively plan for investments with tax sensitivity, but try not to make the decision based on tax alone. In this case, the current President may lower the tax, but what about the next one? Recall, we just had a president who increased the tax rate during his 8-year presidency.
So, to better protect yourself, I would do both—max out pre-tax and after-tax retirement saving vehicles. If you’re working, you might want to make a full contribution to your 401(k)/403(b) account to lower your annual tax liability. At the same time, make a Roth contribution for the future.
Did you know your future withdrawal from any pre-tax saving vehicles may cause your Social Security benefits to be taxed? Thus, if you have any traditional 401(k)/403(b)s or IRAs, you may defer the tax now, but they will “explode” when the RMD (required minimum distribution) time comes. That’s why many people jokingly refer to those pre-tax savings vehicles as “tax bombs.” Therefore, it’s better to prepare and give yourself many options with the saving bucket to tap and generate the least amount of tax. Best!
The rationale behind your strategy is correct. If your tax rate will be lower in the future, then it makes sense to get your tax break now when you're in a higher tax bracket.
President Trump has talked a lot about lowering taxes and simplifying the tax code. When he talks about lowering taxes, he mostly refers to corporate taxes. The changes he has proposed to the individual tax law has more to do with simplifying the tax code. He has proposed reducing the number of tax brackets, doing away with additional Medicare tax, and combining the standard deduction and personal exemptions. Whether or not this gets done and when it gets done is up for debate. With both houses of congress being controlled by Republicans, it's their intention to simplify the code, but nothing substantial is on the table for lowering individual income taxes.
The other consideration you have to make is when you will be retiring and accessing this money. If you aren't retiring for another 10-20 years, we could have a completely different administration in power with a completely different agenda and maybe they are in favor of increasing taxes. Where will our national debt be at that point and will the government be relying heavily on tax revenue to reduce it?
My general advice to people without knowing the specifics of their situation is to diversify not only their investments, but also their account types. Have a portion of your savings in both after-tax (Roth IRA) and pre-tax (Traditional IRA) accounts. In most cases, there are too many variables in the future to determine which is best now.
If there is a tax bill this year, it will most likely be done retroactively from the beginning of the year. And it may not happen this year although I think the odds are good. However, it would depend on your income tax rate and all of your other options. The higher your rate, the more beneficial the pre-tax retirement would be. Just be sure you are aware of the income limits that preclude you from even doing a Roth contribution. If your tax rate is too high, you may not even be able to make a Roth contribution.
You can, however, make an IRA contribution and then convert to a Roth. This is know as a backdoor Roth for people whose income is to high to make a Roth contribution. And you could always do the conversion at a later date.
It is good that you are being proactive and your thinking is logical. It does depend on your total picture though and without knowing all of your particulars, I can't give you a solid answer.
Hope this helps, Dan Stewart CFA®
We do not know what interest rates will be like in the future. Therefore, having some tax diversification among your investment accounts is important. Having a combination of a taxable, tax-differed, and tax-exempt account will be ideal for many individuals. When planning for the long term, you should consider the pros and cons associated with each account.