IRA Insights: Another way to diversify
When investing for retirement, try to have some degree of tax diversification.Investors can benefit from having different types of retirement accounts. Roth IRA contributions, unlike those of traditional IRAs, offer no immediate tax deduction but provide tax-free earnings and withdrawals. Savvy retirees can withdraw from traditional IRAs when in low tax brackets and Roth IRAs when tax rates are higher. Traditional IRAs have larger balances and are more numerous than Roth IRAs. They have been around much longer and get large inflows from 401(k) rollovers.
New contributions are largely going into Roth IRAs.In 2015, more than $2 of every $3 contributed to a Vanguard IRA went into a Roth. Traditional wisdom suggests that younger investors with lower incomes prefer Roth IRAs, while higher-income older investors prefer the immediate tax deduction from a traditional IRA contribution. The contribution trend by age supports this view, but even at older ages, a majority of contributions went into Roth IRAs. This trend is helping to increase investors’ overall tax diversification.
Another way to increase tax diversification: Roth conversions.New contributions are not the only way to increase Roth holdings. Investors who retire with traditional IRAs sometimes take advantage of their lower tax rates to make partial Roth conversions before age 70½, when Required Minimum Distributions (RMDs) begin. Roth IRAs are not subject to RMDs, so they can keep growing tax-free throughout retirement and be withdrawn tax-free as needed. Investors aged 60–70 were responsible for a large percentage of traditional IRA money that was converted to Roth in 2015.
All investing is subject to risk, including the possible loss of the money you invest. We recommend that you consult a tax or financial advisor about your individual situation.
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