Should You Contribute to a Roth 401K instead of the Old Pre-Tax 401K? by Melissa L. MacLeod, CFS Financial Planner

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1 Melissa L. MacLeod is a financial planner with Patrick MacLeod & Cranman/Integrated Financial Group in Atlanta. She helps successful individuals, families and business owners accumulate, grow, preserve and enjoy thier wealth. Melissa can be reached at Securities offered through Securities America, Inc., Member NASD/SIPC. Investment advisory services offered through Securities America Advisors, an SEC Registered Investment Advisor. Melissa L. MacLeod,, representative. Patrick, MacLeod & Cranman, Integrated Financial Group, Inc. and the Securities America Companies are not affiliated. Should You Contribute to a Roth 41K instead of the Old Pre-Tax 41K? by Melissa L. MacLeod, CFS Financial Planner Many of my clients and plan sponsors have for my assistance in evaluating the new Roth 41K. Changing your 41K selection to the Roth configuration should be carefully examined, paying particular attention to some key assumptions. The first question you should ask yourself is whether or not you will be contributing MORE on a pretax basis in order to max out your Roth 41K. If you can set aside enough pre-tax dollars to max out a Roth 41K, then a Roth may be more attractive. If, on the other hand, you are not willing to set aside more dollars (in other words, you want to maintain the same level of take home pay), the choice is not as clear. Roth participants who want to keep their take-home pay at the same levels as with the traditional 41K will see the actual contributions they make into their 41K account decrease. Why? Because contributions to Roth accounts are taxed immediately and only the net after tax remaining is deposited into the Roth account. The rest goes to Uncle Sam. The second critical factor to consider is your tax bracket. You must determine what tax bracket you fall in and weigh it against the tax bracket you are likely to fall in when you retire and begin withdrawing the money. If retirement is several years away, determining the tax brackets of the future may be nothing more than a random guess. I will begin by looking at a case where the participant's tax bracket is the same during the working years as it is at retirement. Consider the following hypothetical, simplistic example where a person has $1, to invest in a single year. Tax Rate Same at Accumulation and Distribution Regular 41K Roth Amount Available to Save $ 1,. $ 1,. Less: Taxes Due at Accumulation $. $ 2,8. Net Amount Deposited into the Account $ 1,. $ 7,2. Years Until Retirement 2 2 Account Value at Retirement $ 32,71.35 $ 23,91.38 Tax Rate at Retirement Distribution 28% 28% Less: Tax Due At Retirement $ 8, Net Available at Retirement $ 23,91.38 $ 23,

2 Notice how the amount available at retirement is the same in both cases? This is because the tax rate is the same during accumulation and at retirement distribution. Now, look what happens when we assume our tax rate is higher at retirement distribution. Tax Rate Higher at Retirement Distribution Regular 41K Roth Amount Available to Save $ 1,. $ 1,. Less: Taxes Due at Accumulation $. $ 2,8. Net Amount Deposited into the Account $ 1,. $ 7,2. Years Until Retirement 2 2 Account Value at Retirement $ 32,71.35 $ 23,91.38 Tax Rate at Retirement Distribution 33% 33% Less: Tax Due At Retirement $ 1, Net Available at Retirement $ 21, $ 23,91.38 When the tax rate is higher at distribution than during accumulation, the Roth option looks better. It is not unusual for someone to have a higher tax rate in retirement than in their working years. Many people building a career expect income levels (and therefore taxes) to increase as their net worth does, putting them in higher brackets. Business owners who sell a company often have higher retirement incomes as a result of the sale. Real estate investors can build high income streams from rental property accumulated over the years. They may sell properties for large profits when they retire. They may also inherit wealth. People also lose deductions in later life (children grow up and no longer provide a deduction, paying off a mortgage, etc.), subjecting more of their income to taxation. And, don't forget, tax rates can be raised at any time! All of these are common scenarios for retirees and they all experience an INCREASE in their tax brackets as a result. What happens when the tax rate at retirement declines? In the following case, the regular, pre-tax 41K fares better. Tax Rate is lower at Retirement Distribution Regular 41K Roth Amount Available to Save $ 1,. $ 1,. Less: Taxes Due at Accumulation $. $ 2,8. Net Amount Deposited into the Account $ 1,. $ 7,2. Years Until Retirement 2 2 Account Value at Retirement $ 32,71.35 $ 23,91.38 Tax Rate at Retirement Distribution 23% 23% Less: Tax Due At Retirement $ 7, Net Available at Retirement $ 24, $ 23,

3 Now let's look at an example where a participant wants to max out the full CONTRIBUTION limit, whether it be a Roth or a pre-tax 41K. To max out the Roth, we will need to set aside more on a pre-tax basis to account for taxes coming out off of the top. In the following scenario, we deposit $2, pre-tax to obtain our maximum allowable contribution to the 41K of $15,, assuming a 28% tax bracket. We also assume the tax bracket is the same at accumulation and retirement. Tax Rate Same at Accumulation and Distribution - Participant Maxing Retirement Regular 41K Roth Additional Amount Available to Save* $ 15,. $ 2, $ 5, % Less: Taxes Due at Accumulation $. $ 5, $ 1, Net Amount Deposited into the Account $ 15,. $ 15,. $ 4,2. 6% Years Until Retirement Account Value at Retirement $ 48,17.3 $ 48,17.5 $ 13, Tax Rate at Retirement Distribution 28% 28% 28% Less: Tax Due At Retirement $ 13, $ 3,771.6 Available at Retirement $ 34,637.6 $ 48,17.5 $ 9, Add: Savings $ 9, Grand Total Available at Retirement $ 44, $ 48,17.5 Is it possible to lower our tax bracket in retirement? In many cases, absolutely! Retirement distribution planning is designed to do exactly that and in many cases, I can keep the retiree in a lower bracket with detailed planning and preparation. At first glance in the preceding example, the Roth seems to do much better, but the comparison falls short without consideration of the additional money this participant had to save. If the participant invests the additional $4,2 remaining after the pretax contribution into the 41K ($2,833-$15, = $5,833 minus 28 percent tax=$4,2 remaining), allow it to grow at 6% and pay tax at the end, our end result is closer. If, after the contribution the tax rate increases to 33 percent, the tax advantage of the Roth is greater as illustrated below. Tax Rate Higher at Retirement Distribution Regular 41K Roth Additional Amount Available to Save* $ 15,. $ 2, $ 5, % Less: Taxes Due at Accumulation $. $ 5, $ 1, Net Amount Deposited into the Account $ 15,. $ 15,. $ 4,2. 6% Years Until Retirement Account Value at Retirement $ 48,17.3 $ 48,17.5 $ 13, Tax Rate at Retirement Distribution 33% 33% 33% Less: Tax Due At Retirement $ 15, $ 4,445.9 Available at Retirement $ 32, $ 48,17.5 $ 9,24.89 Add: Savings $ 9,24.89 Grand Total Available at Retirement $ 41,256.6 $ 48,

4 If the participant's tax rate in retirement decreases, as seen below, the advantage of the Roth holds, though just barely. Tax Rate Higher at Retirement Distribution Regular 41K Roth Additional Amount Available to Save* $ 15,. $ 2, $ 5, % Less: Taxes Due at Accumulation $. $ 5, $ 1, Net Amount Deposited into the Account $ 15,. $ 15,. $ 4,2. 6% Years Until Retirement Account Value at Retirement $ 48,17.3 $ 48,17.5 $ 13, Tax Rate at Retirement Distribution 23% 23% 23% Less: Tax Due At Retirement $ 11,64.62 $ 3,98.1 Available at Retirement $ 37,42.41 $ 48,17.5 $ 1, Add: Savings $ 1, Grand Total Available at Retirement $ 47,414.3 $ 48,17.5 If the earnings in the shaded "additional" column were taxed each year at the current 15 percent capital gains rate, the gap between the results of the Roth and the pre-tax contribution would narrow. In the immediately preceding scenario, the pre-tax 41K would have the advantage. If the additional amount was placed into some other deferred savings vehicle such as an self-directed IRA or an annuity that received the same return, the federal income tax advantages of the Roth and the pre-tax 41K would be the same. If you choose not to set aside more at the beginning to offset the tax bite, (and reducing your take-home pay), the Roth advantage is diminished. Implementing Roth 41K's is fraught with complexities and should be considered carefully. Employers will have additional recordkeeping responsibilities as all Roth contributions must be kept separate from regular. This will result in higher recordkeeping costs which could be passed on to participants. When distributions are made, participants wanting to roll their accounts into IRA's will need to establish two (a traditional and a Roth) and follow through that the distribution was made properly to the two accounts. This can make assets more difficult to manage and increase fees, such as custodial and account maintenance fees. Employees making Roth contributions are depending on Congress to maintain the current tax laws that does not tax accumulated Roth account earnings. If you trust them, consider the history of Social Security. Prior to 1983, there were no taxes on any Social Security benefits. But, in 1983, Congress imposed a tax based on a person's overall income on up to 5% of Social Security benefits. This tax was increased to 85% for those with higher incomes. What is to stop Congress from looking to the untaxed dollars in Roth 41K's and IRA's to defray its huge deficits? Even a phased-in tax like the Social Security tax will erode any small advantage the Roth has over the traditional 41K. With the traditional 41K, the benefit is tangible, and you get it NOW!

5 The choice is yours to make, and I will be happy to discuss any questions you have if you call my office. Thank you for the opportunity to serve your financial needs. Your business is appreciated. Kind Regards, Melissa L. MacLeod Melissa L. MacLeod Patrick, MacLeod & Cranman 66 Peachtree Dunwoody Rd. 6 Embassy Row Suite 4 (77) voice w (77) fax w website: Securities offered through Securities America, Inc., Member NASD/SIPC. Investment advisory services offered through Securities America Advisors, an SEC Registered Investment Advisor. Melissa L. MacLeod,, representative. Patrick, MacLeod & Cranman, Integrated Financial Group, Inc. and the Securities America Companies are not affiliated. Not bank guaranteed, not FDIC insured, may lose value