Your portfolio allocations are how you divide your investments among stocks, bonds and cash, as well as how much is in your pre-tax vs. after-tax accounts.
Your allocations will help you as you enter retirement. Remember to consider the specifics of your retirement when you are planning, like where you want to live and how you want to spend your time.
Roth vs. Pre-Tax Contributions
Here’s another delicate balance you’ll run into with your portfolio: should your contributions be Roth or pre-tax?
The short answer: Stay balanced.
When you contribute money to your retirement plan with Roth contributions, that means you pay taxes now but withdraw the earnings tax free when the time comes. Pre-tax contributions mean you will pay taxes on contributions and earnings when you withdraw them.
This distinction matters because you might be in a different tax bracket now then you would be in retirement. If you’re at a lower tax bracket in retirement, then you could save money by paying taxes at that time.
Remember, the right balance is important. A mix of both Roth and pre-tax contributions tends to work best for most people.
But keep in mind that we are in a low tax rate environment right now. That means that, given the current conditions, it can make sense to contribute to a Roth and pay the taxes now.
The recently-passed SECURE Act is important to note here too, because of the changes to RMDs. If you are already in retirement, it might make sense to do some Roth conversions between now and age 72 to reduce your RMDs.
Income tax and your allocations
I live in New Hampshire where we do not have an income tax. That means that when New Hampshire residents (or those of you who live in the other income-tax-free states) withdraw from an IRA, they aren’t taxed.
If you live in Massachusetts, your state will tax IRA distributions at the net of your cost basis, and it also will not tax social security. However, Maine will tax full IRA distributions. So it’s important to be aware of your state’s taxes.
This isn’t the case for 43 states, who do charge an income tax. How does that impact your allocations?
Mostly, it’s going to change how much pre-tax and Roth contributions you decide to make. If your state doesn’t have an income tax, then you’ll be able to withdraw money in retirement without being charged income tax for that money.
But if you do have an income tax in your state, you want to try to reduce your taxable income in retirement (assuming you’ll be at a lower tax bracket then.) That’s when pre-tax contributions could be a better fit.
The key here is to review the tax laws in your state. If you have a good balance of pre- and post-tax accounts, then you can manage your tax liability to avoid jumping brackets.
About Michael
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