To deduct or not to deduct? That is the question
Tax time is nearly here again, so it's time to start getting organized.
Many of us will be looking to put more money into a 401k, IRA or SEP plan, all with the intention of trying to lower our taxable income this year. However, is this what you should be doing? Let's explore why sometimes it can be good to get a deduction, and other times it is just kicking the can down the road.
IRAs are attractive to many because people often feel they are in a higher tax bracket while they are working than they will be when they are retired. While this may be true for those in the top bracket (33-35 percent), it may not apply to the typical taxpayer. Remember, our tax brackets have gotten much bigger over the past three decades; they are now separated by $50,000 to $75,000. Many Americans may never leave their current bracket, even in retirement.
If this is the case, would it make more sense to pay taxes now while you are working or wait until retirement when you will be living on a fixed income?
To answer this, consider that these are the lowest taxes many of us have seen in our working lives. Remember that from the 1940s through the 1960s our top tax bracket was at or above 90 percent! Additionally, our national debt is more than $15 trillion, and that must be paid at some point. This adds up to the possibility of higher taxes down the road. If this comes to bear, does it still make sense to put off paying those taxes now?
If this is making you think twice about taking that deduction now, there is an option out there for you. You may be able to put your retirement dollars into a Roth IRA this year, rather than a traditional IRA. A Roth allows you to pay your taxes now, and if handled correctly, all the growth on the money can be taken out tax-free at retirement. So no matter what tax bracket you find yourself in during retirement, you will not pay taxes on the money you pull out of your Roth (provided you follow the IRS guidelines for Roth IRAs).
No matter how much money you make, you may still be able to take advantage of a Roth account. While it's true the IRS imposes some restrictions to Roth contributions (referred to as the Phase-Out Income Limit), there's a way to get around this restriction if you exceed the limit; simply make a nondeductible contribution to another IRA, and then convert it to a Roth within the same calendar year.
So while you're scheduling your appointment with your tax preparer or accountant, consider meeting with your financial adviser as well to do some year-end planning to discuss which options make the most sense for your personal situation.
Joe Wirbick is president of Lancaster financial services firm Sequinox and specializes in retirement planning and distribution. This allows him to concentrate on developing strategies that help address the unique issues that confront retirees and those approaching retirement.