One of the first things you need to decide regarding your pension plan is whether you want to pay tax now or later.
If you pay tax later, that means you get a tax deduction for the amount you’ve put in your pension. That could be an IRA, a SEP or a 401(k).
If you pay tax now, it means you do not get a tax deduction. That is the case in a Roth plan, regardless of whether it’s a Roth-IRA or Roth 401(k).
Later, when you pull out your distributions, the initial deposit amount plus the earnings are taxable if you have a traditional pension. You got a tax break initially, and then paid tax on that amount plus its earnings later.
If you pull out a distribution from your pension that did not get an immediate tax deduction, like with a Roth, it is not taxable.
The real question is “Tax now or tax later?”
Here are some example for when it make make sense to use a Roth instead of a traditional pension plan:
- You expect your tax rate to rise in retirement,
- You expect your tax rate to remain the same in retirement,
- You don’t need to save more in your pension (traditional pension maximums are higher than Roth maximums), or
- You’re investing in something that is going to go way up in value.
Are any of these 4 true for you? If so, consider funding a Roth.
Remember that if you have a business pension, like a SEP-IRA or 401(k), you must have the plan set up before year end. You can fund it by the filing date of the return, but it must be set up in advance.