Why should you split your pension contributions

I split my 401(k) contributions 50/50 between a Standard and a Roth. The thought process is that it allows me to withdraw money tax-free on big expenses yretired ears and the opposite in normal years. Is this the correct thought process and a good idea?

Planning for your retirement means balancing what you’re willing to put aside now and what you’ll pay in taxes later in retirement.

For these reasons, and a few more, splitting your retirement savings between a traditional 401(k) and a Roth 401(k) — or IRA — is good planning.

In a traditional 401(k), you make pre-tax contributions and pay taxes in retirement when you retire. Contributions to a Roth 401(k) are already taxed, so money withdrawn is tax-free, as long as you’ve had the Roth account for at least five years.

While not everyone has employer-sponsored Roth offers or even a 401(k), the ability to share your retirement savings in the same way can be done on your own using an IRA. traditional and a Roth IRA.

“It comes down to taxes,” says Catherine Golladay, senior vice president of Schwab Retirement Plan Services in Richfield, Ohio.

The problem, especially as a young person, is that no one knows what will happen to tax rates or your income by the time you retire, and these things can make a big difference in the long run.

« A lot of young people, as they progress in their careers, expect to make more money and be in a higher tax bracket, » Golladay says.

In this case, it may be beneficial to put money into a Roth when you are younger and in your lower tax bracket.

« For younger workers, they have a longer time horizon for those contributions to grow tax-free, » Golladay says.

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People in their 40s, 50s, or 60s don’t have as much time to grow that money. Still, if you’re considering a Roth and you’re more than five years away from retirement, Golladay suggests contributing even a little.

You can retire from a Roth as early as 59½. The only caveat is that five years must pass from your first contribution before you can withdraw the income tax-free.

« I’ve seen people put in as little as 1% [of their retirement savings] in the Roth, just to start the five-year clock,” she says. The annual limit for all 401(k) contributions in 2018 is $18,500.

But if you’re saving to set aside retirement funds as they are, and the entire Roth’s tax burden is too high now, splitting your contributions between a traditional and a Roth may be a solid choice.

Besides shifting the tax burden when you contribute to your retirement funds and allowing flexibility when you withdraw, there are other benefits to a traditional/Roth 401(k) split.

“More sophisticated tax strategies come into play when you have these options,” Golladay says.

If you are approaching retirement and approaching the mandatory retirement age of 70.5, you have some leeway. Of course, you’ll have to take the required minimum distributions from both account types after you reach age 70.5, but your Roth 401(k) withdrawals will be tax-free.

Closer to retirement, you may want to transfer both to Roth IRAs to avoid the required minimum distributions. You don’t need to take the required minimum distributions on a Roth IRA before its owner dies. Or, you can turn the traditional 401(k) into a traditional IRA and the Roth 401(k) into a Roth IRA to retain some tax diversification.

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“In years when an individual has a big expense, taking the extra amount of money out of the tax-free source — from the Roth — is a huge benefit,” Golladay says.

The other thing she sees doing is using the two funds to manage their marginal tax bracket, she says. They can take money out of the tax-deferred fund, and anything they need over a certain amount they’ll take out of their Roth to avoid moving to the next income bracket.

« With a 50/50, you maximize the tax diversification strategy, » Golladay says. « Even if you don’t know what tax bracket you’ll be in when you retire, you have the best of both worlds. »

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CNN Money (New York) First published May 10, 2018: 1:24 p.m. ET