When it comes to retirement investing, you have a few choices for accounts that provide tax breaks. Many people pick traditional 401(k) and IRA accounts because they provide immediate tax savings in the year you make your contributions. That can make it easier to save, although the downside is that you're deferring your tax bill until later.
You have another option, though: a Roth IRA (and Roth 401(k) if your employer offers one). Roth accounts are contributed to with after-tax dollars. But as long as you fulfill certain requirements, withdrawals are made tax free.
Not having to worry about owing the IRS any money as a retiree has always had some big benefits, but the current economic situation in America may mean that contributing to a Roth makes more sense than ever. Here's why.
Roth IRAs may help you save more on taxes in light of the coronavirus
Traditionally, most experts recommend you invest in a Roth IRA if you think your tax rate will be higher when you start making withdrawals than it is now. If deducting your contribution today could save you 22% in taxes but claiming the tax deduction 20 years from now could save you 35% in taxes, you're obviously better off with the later option.
Of course, predicting what your future tax rate will be can be a challenge since it depends on the amount of income you have, the deductions you can claim, and government tax policy at the time. But the government's actions over the last few weeks (and years) have significantly increased the chances that sharp tax increases will be needed over time.
On March 6, the Congressional Budget Office projected federal spending in 2020 could be close to $4.7 trillion -- and then the U.S. government spent $2.4 trillion on coronavirus relief bills. By comparison, the cost of Social Security is around $1 trillion a year, while defense spending comes in at about $676 billion.
With the government already running a deficit, the addition of the coronavirus spending will likely result in another $3.5 trillion tacked onto the national debt. The bill for this will come due someday, and when it does, tax increases are almost sure to be necessary.
Meanwhile, the 2018 tax reform bill lowered rates for most Americans, with some of those cuts made permanent and others lasting until 2025. Because of this legislation, tax rates are near the lowest they've ever been.
If you'd rather pay your taxes now at a discounted rate and make sure your retirement funds aren't subject to the big tax increases that COVID-19 spending could usher in, investing in a Roth IRA is your best bet.
Don't pass up the chance to save in a Roth IRA
If you believe your tax rate will be higher as a senior, contributing to a Roth IRA is the smartest thing you can do. While it may require a little extra sacrifice without getting a tax deduction in the year you make your contributions, the savings you realize as a senior should be well worth it.