How to Prioritize Tax Advantaged Accounts

Morningstar

Jason Stipp: I’m Jason Stipp with Morningstar. Its tax relief week on Morningstar.com
and today we’re talking about your tax advantage account so here your
401k’s your IRA’s your Roth IRAs there’s a lot of options there so here
with me to talk through some of these is Morningstar’s Christine Benz.
She’s Director of Personal Finance thanks for joining me Christine.

Christine Benz: Jason nice to be here.

Jason: So when I’m thinking about these tax advantaged accounts they’re treated
differently and they have some different pros and some different benefits
where should I start with where I should put my money away from me for
time and accounts?

Christine: The first starting point is to check on whether you’re earning any sort of
matching contributions on your company retirement plan contributions so
that’s the starting point if you are you should definitely invest at least
enough to earn that match regardless of whether the company retirement
plan is good or not so good.

Jason: So these are your 401k. The 403b these are the ones where they take
money out of your pay check and put it in before taxes and put it in so that
you kind of get a little bit of a tax benefit now for those and then when
you take the money out later you are actually taxed on that?

Christine: Exactly and those company retirement plans are so easy to invest in
because you have that forced discipline and also as you said the money is
coming out on your pre tax basis so its not really all that painful.

Jason: Right so we’re going to talk a little bit in separate video about how to kind
of determine whether your 401k is good quality but certainly you want to
at least try to get that match if you can but let’s say that we know we sort
of examine our 401k the options maybe don’t look that great it seems a
little expensive what would be my next step then if I still had money I
wanted to invest?

Christine: For most investors, the Roth IRA is going to be a good next step and there
are a couple of key reasons first of all the tax treatment can be particularly
attractive if you think you maybe in a higher tax bracket when you retire
and maybe we’ll all be in a higher tax bracket when we retire so the
opportunity to get tax free withdrawals is very attractive and also you
don’t have to take withdrawals in retirement if you don’t need that money
so you can pass it on to your heirs if you want to.

Any other key advantage to any sort of IRA is that open architecture
which you do not get with most 401k plans where you are confined to a
preset menu choices.

Jason: So certainly a lot more options and a lot more flexibility by going to that
IRA the taxes are different with a Roth IRA in the way they’re handled so
you know I think that could be beneficial even if my 401k seems like its
pretty good. Should I still think about putting money in a Roth IRA?

Christine: Yes and you hit on something really important Jason and that’s tax
diversification so we all know about asset class diversification having
money parked among stocks and bonds and international and so forth. We
also want the same thing with your tax treatment of your retirement assets
so maybe you’re a person who has amassed a lot of assets in your 401k so
you’ve got a lot of money that’s going to be taxed upon withdrawal. Its an
attractive idea to get at least some of your assets into that tax free
withdrawal column which is what you get with a the Roth IRA.

Jason: So when you get down the line you have a little more options a little more
flexibility depending on what the situation looks like?

Christine: Exactly.

Jason: So one more option that’s available that to some investors and maybe it
will be available to more as we go a long as the Roth 401k so here’s
somebody else in the mix, how should I think about that if its available to
me?

Christine: Its increasingly available in plans and I think there are two categories of
individuals for whom the Roth 401k contributions make a lot of sense.
First would be the person just starting out and maybe in a low tax bracket
relative to where they think they’ll be women retired so that would be one
candidate and the other would be the person, the same person who might
have already amassed a lot of assets in a traditional 401k who is looking
for some retirement assets that will not be taxed upon withdrawal
retirement so for that individual maybe they’re maxing out the 401k
contributions perhaps have not been able to contribute to a Roth IRA to
date due to income limitations that person might want to look at a ROTH
401k as well.

Jason: Gives them the option to have a little bit of that diversification if they want
to on the tax side.

Christine: Exactly.

Jason: Well thank you for your insights Christine.

Christine: Thanks Jason.

Jason: For Morningstar I’m Jason Stipp thanks for watching.