1. Choose Between Two Ways to Invest in Your Plan.
[Note to financial professional: Please refer to slide.]
Content contained herein is not intended to serve as impartial investment or fiduciary advice. The content has been developed by Capital Group which receives fees for managing, distributing and/or servicing its investments.
Investments are not FDIC- insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Choose Between Two Ways to Invest in Your Plan.
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2. We live in a world that offers us choices at every turn.
Consider the last time you went to a shopping mall. As you were checking out the items for sale, you probably noticed various colors, shapes and sizes. Depending on your personal preferences, you could then select the best fit for your needs and desires.
Similarly, your employer’s retirement plan offers you choices. You can decide how much to save, choose the investment options that suit your preferences and even decide when to begin participating.
Today, I’d like to talk to you about another important choice you have when saving in your plan — you can choose to make pretax contributions or Roth after-tax contributions.
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3. Do You Want to Pay Taxes Now or Later?
Are Plan Contributions Taxed?
Are Withdrawals (Including Earnings) Taxed? No
Yes
No*
Pretax Employee Contributions
For our purposes today, we’re going to boil this topic down to a single question: when it comes to the money you’re investing for retirement, do you want to pay taxes now or later?
If you’d prefer to pay taxes later, you can contribute to your employer’s plan on a pretax basis. This means that you don’t pay income taxes on your contributions and accumulated earnings until you withdraw it in retirement.
If you’d prefer to pay taxes now, you can contribute to your plan on a Roth after-tax basis. By doing so, you invest money from your paycheck that’s already been taxed. With Roth, you don’t have to pay taxes on the contributions and their earnings when you take qualified withdrawals in retirement.
Both options have their advantages, and, if you wish, you can even use a combination of bothapproaches.
[Note to financial professional: If the plan offers employer contributions such as matching or profit-sharing, please note that these contributions are always pretax.]
Roth Employee Contributions
Employer Contributions, If Applicable (e.g., Match, Profit Sharing)
* Roth withdrawals are tax-free for qualified distributions as long as you’re at least 59½ years old and have had the account for at least five years.
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4. When Given the Option … 20% of participants choose Roth contributions
You may wonder why you haven’t heard much about Roth after-tax contributions until recently.
Actually, it wasn’t until 2006 that employers had the option of allowing Roth after-tax contributions in their retirement plans. Prior to that, all contributions were made on a pretax basis.
Since that time, the popularity of Roth contributions has increased.
But just as you wouldn’t purchase something to wear before making sure it’s a good fit, you’ll want to decide which contribution type makes more sense for you. Let’s take a look at each now.
… and 80% select pretax
Source: PSCA’s 59th Annual Survey of Profit Sharing and 401(k) Plans, reflecting 2015 plan experience.
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5. Pretax Contributions They’re tax-deductible.
Your earnings compound on a tax-deferred basis.
Withdrawals at retirement are taxable.
First, let’s look at the pretax option. Pretax contributions are taken out of your paycheck before income taxes are calculated, which means you pay income taxes on your wages minus any money you contribute to your retirement plan account. So, in effect, you postpone paying taxes on your contributions and you reduce your annual taxable income in the year you make the contributions.
Then, the money you contribute can grow tax-deferred until you withdraw it during retirement. That’s when you’ll pay taxes on your pretax contributions and any of your accumulated earnings.
Keep in mind that early withdrawals of pretax contributions may be subject to penalties in addition to income taxes. For example, a 10% early withdrawal penalty may apply on distributions made before you reach age 59½, unless an exception applies, such as leaving your job at age 55 or later.
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6. Consider Pretax Contributions if:
You believe your tax rate at retirement will be lower.
You’re currently in your peak earning years.
You could benefit from lowering your current taxable income.
Why would you decide to contribute on a pretax basis rather than on an after-tax basis?
You may believe that your tax rate in retirement will be lower than it is today.
If you’re in your peak earning years, you may decide that it’s not ideal to pay taxes now due to the relatively high tax bracket you’re currently in.
If lowering your annual taxable income (getting a tax break now) works to your advantage, making pretax contributions may be a good option.
Finally, you may just appreciate the certainty of today’s tax break rather than waiting to see what your tax scenario is down the road.
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7. Roth Contributions They’re not tax- deductible.
Qualified withdrawals are tax-free.
You don’t have to worry about future tax rates.
Now let’s talk about Roth after-tax contributions.
Roth contributions are taken out of your paycheck after taxes have been calculated — so you don’t get a tax break in the year you make the contribution. But you don’t have to pay any taxes on the money or its earnings when you take qualified withdrawals during retirement.
This tax-free feature is what’s unique about Roth. You don’t have to worry about future income tax rates, and the tax-free withdrawals you take during retirement could give you more money to live on when you’re no longer working.
Roth contributions and any earnings can be withdrawn free of federal income taxes and penalties if:
The first Roth contribution to your account was made at least five years before, AND
You’re at least age 59½, you’ve become disabled, or have passed away and the account has been transferred to your beneficiaries.
Keep in mind that early withdrawals of earnings from a Roth after-tax account may also be subject to penalties in addition to income taxes. For example, a 10% early withdrawal penalty may apply on distributions made before you reach age 59½, unless an exception applies, such as leaving your job at age 55 or later.
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8. Consider Roth Contributions if:
You believe your tax rate at retirement will be higher.
You’re young and have many years to invest.
Your income level prevents you from contributing to a Roth IRA.
Roth contributions may be a good option if:
You believe that your tax rate at retirement will be higher than your current tax rate
You’re young and have many years to invest (the more years you have, the bigger the tax-free savings could be), OR
You’re a highly compensated worker whose salary prevents you from contributing to a Roth IRA. Regardless of your income level, you can make Roth after-tax contributions to your employer’s plan.
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9. Monthly After-Tax Retirement Withdrawals (After 40 Years)
Different Scenarios Can Yield Different Results
Tax Rate at Retirement
Monthly After-Tax Retirement Withdrawals (After 40 Years)
Increases 5%
Decreases 5%
Stays the Same
Let’s look at a hypothetical projection for two retirement plan participants, one who contributed on a pretax basis and another who contributed on a Roth basis. [Note to financial professional: Refer to slide. Be sure to read the important disclosure at the bottom of the screen.]
In this example, Sofia invests $400 per month in pretax contributions. Kenji, on the other hand, invests $300 per month on a Roth basis (the equivalent of $400 in pretax money, assuming a 25% tax rate).
Who fared better? Well, it all depends on whether their tax rate at retirement goes up or down. When taxes increased, you can see that Kenji was better off. When the tax rate fell, then Sofia was in a better position.
Keep this in mind as you think about which contribution type makes more sense for you.
Assumes an 8% average annual return compounded monthly and an annual withdrawal rate of 4% after a 40-year accumulation period. Without investment growth/loss during retirement, a 4% annual withdrawal rate would deplete retirement savings in 25 years. Examples are for illustrative purposes only and do not reflect the results of any particular investment, which will fluctuate with market conditions, or taxes that may be owed on tax-deferred contributions, including the 10% penalty for withdrawals taken before age 59½.
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10. There Are Resources to Help You
Traditional vs. Roth 401(k)/403(b) Analyzer Results
Based on the information you entered, a Roth account may be worth more than a traditional account at retirement.
American Funds, your retirement plan provider, offers tools that can help you decide.
For example, the Traditional vs. Roth 401(k)/403(b) analyzer at americanfundsretirement.com lets you compare and project different potential scenarios.
Of course, as your plan’s financial professional, I’m also happy to meet with you and assess some factors that could influence your decision. I’m here to help you.
1 The analyzer calculates average annual withdrawal amounts by assuming that no balance remains when withdrawals end. Early withdrawal penalties and required minimum distributions are not taken into account. The analyzer assumes that all traditional account withdrawals are taxable and that all Roth account withdrawals are qualified tax-free distributions.
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11. Which is the best fit for YOU?
Both options we’ve talked about today can be good ways to invest for your retirement, and each offers tax benefits.
If you can’t decide between the two types, you can split your contribution between them — and benefit from the tax advantages of each. Making both types of contributions can give you even more flexibility when you start withdrawing money during retirement. Keep in mind that some benefits in retirement are tied to your annual taxable income. If your withdrawals from pretax accounts put you close to the cut-off for those benefits, withdrawals from your tax-free accounts can help you preserve those benefits.
A benefit of having both tax-deferred and tax-free assets to draw from in retirement is tax diversification. A tax-diversified portfolio can enable you to hedge against a future tax increase and provide critical flexibility when it comes to withdrawing your money in retirement, which may help your nest egg last longer.
I’d like you to keep in mind that making either contribution type can get you closer to your retirement goals. Depending on your situation, both pretax contributions and Roth after-tax contributions can work for you. They both have one thing in common: helping you invest for the long term.
Regardless of which approach you choose, one important thing you can do for yourself is to make contributions to your retirement plan account on a regular basis. And, if you can, try to increase those contributions over time so that eventually you may have enough saved for retirement.
I hope what we’ve discussed today has been informative and that you’re closer to being able to decide which approach best fits your situation.
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12. American Funds Is a Key Provider for Your Retirement Plan
Since 1931, American Funds has invested with a long-term focus and attention to risk.
Nearly half of the 56 million investor accounts in the American Funds are retirement accounts.
Your employer has selected a key provider for your retirement plan — American Funds from Capital Group.
There are 56 million investor accounts in the American Funds, and nearly half of those are retirement accounts.
Since 1931, American Funds has invested with a long-term focus and attention to risk — both are key to effective retirement planning.
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13. Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
This material was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed by U.S. federal tax laws. Retirement withdrawal projections assume an 8% average annual return compounded monthly and an annual withdrawal rate of 4% after a 40-year accumulation period. These are point-in-time views and as such do not take into account any growth or loss during retirement. Without investment growth/loss during retirement, a 4% annual withdrawal rate would deplete retirement savings in 25 years. Examples are for illustrative purposes only and do not reflect the results of any particular investment, which will fluctuate with market conditions, or taxes that may be owed on tax-deferred contributions, including the 10% penalty for withdrawals taken before age 59½. Regular investing does not ensure a profit or protect against loss in a declining market.
[Note to financial professional: Refer to slide. Give your audience time to read important disclosure.]
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14. [Note to financial professionals: Thank employees for attending and let them know how to get in touch with you if they need further assistance.]
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