Will I have to pay taxes on the gains generated by my retirement accounts once I am in retirement?
I am 38 years old. I have a 403(b) account as well as an elective deferral which reduces my salary, pre-tax. Will I have to pay taxes on the gains generated by these accounts in retirement?
I'm considering using ordinary dividend income from a mutual fund to start either a traditional or a Roth IRA. If open a traditional IRA in 2018, can I deduct my contribution from my AGI for that tax year? I know I can't deduct the Roth IRA and that I wont pay taxes on the Roth IRA in retirement. For either types of IRAs, will I pay taxes on the growth/gains in retirement?
Congratulations on saving for retirement and maximizing your contributions. As for your tax questions, you will not be paying taxes directly on the gains of your investments. With a ROTH IRA that money is tax free once you reach age 59 and a half. For an IRA or 403(b) account, once you reach 59 and a half you are taxed at your ordinary income tax rate on withdrawals from the account.
Additionally, you can deduct your contributions from AGI but the amount you are able to deduct is adjusted based on your income and filing status. For single taxpayers it is 100% deductible with a MAGI of < $63,000 and partical deduction up to a MAGI of $73,000. If you are married filing jointly it is a full deduction up to a MAGI of $101,000 and partial deduction of up to a MAGI of $121,000.
Sounds like a plan. I'd suggest looking into ETF's instead of mutual funds to generate dividend income. With the typically lower fees your yield would be higher for a similar strategy/risk level. And don't assume higher is better. Look at historic total returns, not just yield.
For a Roth IRA, you are correct you do not get a tax deduction now, but your withdraws are tax-free after 59 1/2. For a traditional IRA you can make a 2018 deduction as long as you contribute before you file your 2018 income tax return, up to April 15, 2019.
You ask good questions and without knowing more details about your income level etc... some of my thoughts may not be accurate or suitable. Any distributions from a Traditional IRA is ordinary income in the year you take distributions. And you will be required to take Minimum Required Distributions (MRDs) when you reach 70 1/2 based upon your life expectancy. Roth IRAs are tax free & penalty free if you meet certain, simple to achieve rules.
But both types of IRAs get phased out if you income is too high and IF you contribute to a retirement plan like a 401k or 403b you will begin to get phased out of a Traditional IRA when your modified adjusted gross income (AGI) reaches $61,000 — or $98,000 if married filing jointly. It is completely phased out when your income is more than $71,000 — or $118,000 if married filing jointly. For married couples, this phase-out range increases to $183,000 to $193,000 for couples who have only one spouse who was an active participant in a company plan.
With Roth IRAs, the phase out begins when your modified AGI reaches $114,000 — or $181,000 if married filing jointly and is completely phased out when your income is more than $129,000 — or $191,000 if married filing jointly. This is why without knowing your income or whether you are married etc... I cannot give you great answers.
That said and again, with Traditional IRAs you get a tax deduction going in and therefore pay ordinary income tax when you take distributions. With a Roth, because you didn't get a deduction going in, it is not taxed coming out and if you meet the 5 year rule and don't take distributions until 59 1/2, the growth will be both penalty & tax free. One benefit of a Roth is that you can take out contributions at any time for any reason without any penalties or taxes. It is only the growth on the Roth that needs to meet certain criteria to be tax free. So it can be a little more flexible.
The math dictates the younger you are and the lower tax rate you are in, the more attractive the Roth becomes. This is because you have more time to compound the assets & it is not taxed (yet) upon retirement. So if your income it not too high, the Roth may be a better solution.
This should give you plenty to think about to determine your best option for the type of account to use. Now you need to come up with the best strategy(s) for your situation. In my opinion, strategy is trumps all else when investing.
Hope this helps and best of luck, Dan Stewart CFA®