Plans for 401(k) may depend on tax brackets

A few weeks ago,this column dealt with a reader's question about 401(k)s and individual retirement accounts.

"If you hit 59 1/2, but don't need to take out any of your 401(k) or IRA money yet, is it best to leave it alone?" this reader asked. "Or should you check with your accountant — decide how much to take out (without moving up in a tax bracket) each year, take it out, let it be taxed, then put the money into a Roth (IRA)?"

With help from a financial adviser, I offered some thoughts on the matter. But since then, a few other financial advisers have asked if they could add their two cents.

First, remember that, in a traditional IRA, dollars are effectively contributed before taxes, as contributions are generally tax deductible. The traditional IRA grows tax-deferred, but it is taxed at withdrawal.

However, Roger Smedley and Sharla Jessop of Salt Lake-based Smedley Financial Services sent me an e-mail pointing out that, if you are covered by a retirement plan at work and have an adjusted gross income between $70,000 and $80,000 (for 2005) as a married couple filing jointly, the ability to deduct your traditional IRA is gradually phased out. For a single taxpayer covered by a retirement plan, the deductibility is gradually phased out between $50,000 and $60,000 AGI.

In a Roth IRA, dollars are contributed after tax, they wrote. That means there is no tax deduction with a Roth, but it grows tax-free and withdrawals are tax-free.

Now for the question of whether this reader should take her traditional IRA and convert it to a Roth. Roger and Sharla say that, if you will be in the same tax bracket when you take the money out of a traditional IRA or a Roth IRA as you are today, it makes no difference as far as the end result. Assuming the performance is the same, you will have identical amounts of money in the traditional and the Roth.

But most people will not be in an identical tax bracket in the future. So, the Smedley folks wrote, if you think you will be in a lower tax bracket when you start taking withdrawals, don't convert your traditional IRA to a Roth. If you think you will be in a higher tax bracket in the future, consider converting your traditional IRA to a Roth.

"For many people, the Roth IRA is the first account you want to put money into and the last account you want to take money out of," Roger and Sharla wrote.

Jerry Taylor, regional leader for Primerica Financial Services in Bountiful, had a slightly different take on the question.