Blend retirement savings with tax benefits


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Dear Dr. Don,
I have been placing as much money as I can in my 401(k). I’m currently placing 27 percent of my salary into the account. I’m maxing out the annual contribution at $17,500, as well as with a $5,500 catch-up contribution. This also helps me reduce my income tax bill. Should I continue to do this? I only have five years until I plan to retire. Should I reduce the amount going into the 401(k) and reallocate it to a traditional or Roth individual retirement account?

— Pat Pecuniary

Dear Pat,
Your ability to make tax-deductible contributions to a traditional IRA when you could contribute to an employer-provided 401(k) plan may be limited. There are also income limitations on who can contribute to a Roth IRA. Even if you can’t make deductible contributions to a traditional IRA, you can still contribute after-tax dollars. You could then choose to convert the traditional IRA into a Roth IRA. The conversion is not subject to income limits.

There’s a tax diversification case to be made for having some money in a Roth IRA compared with a 401(k) plan or a traditional IRA. Qualified distributions out of a Roth IRA are tax-free. Roth IRAs also aren’t subject to required minimum distributions, or RMDs, while the account holder is still alive.

Another key issue involves your marginal tax rate. What’s the tax rate now and what will it be when you take your distributions? Workers who are five years from retirement, like you, are now likely to be in a higher tax bracket than when retired.

Based on what you’ve told me, I don’t see a compelling reason to throttle back on your 401(k) contributions to add tax diversification to your retirement nest egg. For 2015, people over 50 may contribute up to $6,500 to an IRA. If you want a little diversification over the next five years in your retirement accounts, spread the money between the accounts. That’s as long as it doesn’t eat into any company matching contributions.

Check out Bankrate’s “Roth versus traditional IRA calculator.” Since the benefits of a 401(k) plan are close to a traditional IRA, you can use the calculator to help decide where it makes sense to put your money. You can always consult a tax professional if you want more detailed information.

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