Let’s get practical for a bit and talk about retirement. For some, it’s a long way off. Others may have already begun.
While finances certainly aren’t the only consideration, they’re often the most important factor behind any given individual’s ability to move into retirement. This post isn’t going to solve all your retirement problems, but it might point you to a unique opportunity that will help you years from now.
For most people, an Individual Retirement Account (IRA) or a 401k through an employer are the most accessible ways of saving for retirement. That’s where you set aside a certain amount of pre-tax money from your paycheck into your retirement account. It saves you money on taxes right away (by reducing your taxable income), but you’ll have to pay taxes on it later. You invest it for years, and the balance (hopefully) grows, and then as you withdraw it from the account during retirement, Uncle Sam finally gets his bite at the apple.
On the flip side is something called a Roth IRA. This is a retirement account where you use money from your take-home pay (you’ve already paid taxes on it) to put in your retirement account. Your investments grow (hopefully) over time, and then when you need to start withdrawing money from that account in retirement, there’s no need to pay taxes on the withdrawals because you’ve funded the account using money that’s already been taxed.
Ideally you’d want a mix of both types of accounts as you approach retirement. Many people only have 401k assets. The tricky part about them is they’re a little misleading. Whatever balance you see in that account is not actually the amount you get to use for your expenses; depending on your tax bracket, Uncle Sam could take a huge bite (in addition to state taxes). One nice thing about a Roth IRA is that the amount you see in your account is what you get to keep (minus any fees from your administrator, etc.).
The biggest question then is: “should I invest in a 401k or in a Roth?” The mathematical answer is: it depends on when you’re likely to have the lower amount of taxable income; if you’re in the lower tax brackets right now (10-12%) and can afford to contribute to retirement accounts, pay your taxes now (use a Roth IRA). If you’re in a moderate or higher bracket right now and you expect to have lower taxable income in retirement, it probably makes sense to delay paying your taxes until you withdraw cash from the account (use a 401k or traditional IRA).
Early in this post, though, I mentioned a unique opportunity. Right now the U.S. probably has the lowest federal income tax rates we’re going to see for a very long time. With the amount of debt we as a nation are carrying right now, it actually doesn’t make sense that our income taxes are as low as they are. I personally find it difficult to believe I’ll ever see lower tax rates than what we currently have. If you believe politicians are more likely to raise future taxes than they are to lower them, you might consider doing what’s called a Roth conversion.
A Roth conversion is the process of converting pre-tax (401k/traditional IRA) retirement money into retirement money that won’t be taxed again. You’re essentially using a special maneuver to pay taxes on the money being converted, eliminating the need to pay taxes on that money in the future. You move the money administratively, and then you settle up with the tax man when you do your annual taxes by the following April 15th tax deadline. There are a few important things to keep in mind, though.
- Even though it’s for retirement, the amount of money you convert counts as taxable income during the tax year the conversion occurs. If you’re single and have $60,000 of taxable income, then you convert $10,000, not only is your taxable income now $70,000, but you’ve actually also elevated part of your income into the next tax bracket. For that demographic, income above $64,200 gets taxed at a higher rate. If you’re going to do a Roth conversion, keep an eye on what the conversion amount is going to do to your total taxable income for the year. You may want to strategically spread out the conversions over several different tax years.
- You should have cash on hand to pay the bill come tax time. Don’t try to convert a chunk and assume you’ll end up with a smaller percent of it because the taxes get withheld from it. It doesn’t work that way. It’s like any other reason you owe taxes come April 15…you need to pay what you owe, and you don’t ordinarily do it using retirement money. Only do a Roth conversion if you’re going to have cash on hand to pay the extra tax. If you’re in the 12% tax bracket, every $500 you can throw at a Roth conversion will get you $4,167. If you’re living in the 22% bracket that same $500 loses some oomph; in that bracket $500 will only get you $2,273. Before the tax rates we currently have, the 12% bracket would have been the 15% bracket (and you’d only have converted $3,333 rather than $4,167 for every $500) and the 22% bracket would have been the 25% bracket (netting only $2,000 instead of $2,273 for every $500 you spend).
- It’s probably not a good idea to convert 100% of your retirement assets into the Roth category. Even though you’d effectively have zero income to report to the IRS come tax time, the standard deduction still gives you some money tax free. For 2026, the standard deduction for single filers is $16,100 (and twice that for married filing jointly). If you spend the money to convert everything you’ve got into Roth assets, you’re foregoing an opportunity to get a free pass on that amount of taxable money. Married couples can take up to $32,200 from their 401k without paying any federal taxes, and then on top of that still have quite a bit of cap space to further convert additional assets to Roth at a low tax cost if they have spare cash on hand. Additionally, now through 2028, people 65 and older get an additional $6,000 deduction on their taxes. (You can also use charitable donations from your 401k/IRA to satisfy your Required Minimum Distributions (RMDs).
- This discussion is for federal taxes only; it doesn’t consider state taxes. States vary widely in their taxes, especially when it comes to determining whether or not to tax your social security benefits. Converting a big chunk of retirement money might force you to pay taxes on your social security when you otherwise wouldn’t have needed to, or increase your out-of-pocket Medicare costs, and that’s probably moving you in the wrong direction.
- Talk to a professional advisor/tax preparer to get the best advice on your particular situation.