Saving for retirement is critical to long-term financial success and comfort — but one expert says you may be doing it all wrong.
The two most popular investing vehicles for retirement include 401(k) and IRA accounts, each of which have traditional and Roth versions. Traditional accounts are funded with pre-tax dollars, which are taxed at the time of withdrawal, while Roths are funded with after-tax contributions so the money grows tax-free and withdrawals are not taxed. In addition, Roth accounts are exempt from required minimum distributions.
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Typically, investors who think they’ll be in a lower tax bracket when they retire, like higher earners, may prefer traditional accounts, while people at the beginning of their careers not yet earning peak incomes might opt for a Roth.
Ed Slott disagrees and says Roth accounts are for everyone at any time. The certified public accountant at his namesake company, which specializes in IRA investing and analysis, is the author of “The Retirement Savings Time Bomb Ticks Louder: How to Avoid Unnecessary Tax Landmines, Defuse the Latest Threats to Your Retirement Savings, and Ignite Your Financial Freedom.” Slott says savers will probably end up paying more if they wait to pay the taxes on their distributions.
The current tax rates set by the Tax Cuts and Jobs Act are also expected to sunset at the end of 2025, and it is not yet clear what the new rates or brackets will be.
Slott says he’s seen the repercussions of waiting before. While working on one tax return for a client who preferred a traditional retirement account during his higher-earning years, he found that his client’s income was higher in retirement than during his best income years because his IRA grew so much and his required minimum distributions were more than the income he had when he was working. His client was shocked, but he wasn’t.
Slott spoke with MarketWatch about how to know if a Roth account is right for you, what to do if you don’t have a Roth 401(k) option at work and how to weigh the pros and cons of a tax bill in the present.
MarketWatch: Why did you write this book?
Ed Slott: The most important thing is the ticking tax time bomb. The tax that people don’t realize is building up in IRAs and 401(k)s. That money has not yet been taxed. You get deductions as you contribute and that is the deal. You get the deductions up front, and just like any deal with the devil, there is a day of reckoning — that’s when you have to take that money out. What I’m afraid of is future higher taxes. Given the national debt situation, if Congress ever decides to do anything about that debt, they may never, but let’s say they get serious, there is going to be a critical point. The people at the highest risk of taxes getting raised are the people with IRA money. It’s like a big juicy steak to Congress.
MW: Do you think people think of this when they’re contributing?
Slott: Most people are shortsighted. Even with the market doing well — well the last few days who knows — but the long-term market doing well, they look at the account balance. A lot of that money is owed back to the government. They think that’s their money, and that’s dangerous. You have $1 million in an IRA or 401(k), you may think that you will use that for retirement. You can’t get to that money unless you pay taxes first, and you don’t know what that is.
MW: So what is the argument for using traditional accounts versus something like a Roth?
Slott: I am out there on my own with that but I say there is no reason to contribute to a [traditional] 401(k) or IRA because you’re just building up a future tax bill. Get the money out. Move to a Roth and build a tax-free account. A Roth is insurance against what taxes can do to your standard of living in retirement. You have a debt on your retirement account — your IRA is an IOU to the IRS. It’s kind of like a mortgage on a retirement account, but with a mortgage, everyone understands that. You know how much you will owe, you look at the statement. With a retirement account, you don’t know how much. Imagine you went in for a mortgage and you did your homework, and you asked the bank questions like, “What’s the interest rate?” And the banker said, “Don’t worry about it.” Instead, the banker said, “We will tell you how much you owe based on how much we need it and when.” Who would sign up for that?
MW: What about the people closer to retirement who maybe can’t switch so easily?
Slott: Use up today’s tax brackets. These are historically low rates. I have an always rule because it’s always true — always pay taxes at the lowest rates. It is very simple. Nobody likes paying taxes up front so they let it go.
MW: Traditional accounts are usually more ideal for people in their higher-earning years. How do you strike that balance when you’re earning more than you may later on?
Slott: That is the No. 1 question when we do training programs. The whole thing is moving your money from accounts with forever tax to never tax. It is all one big giant bet of where you think tax rates will be. I believe they’ll be higher, but if Congress does nothing about the problem and tax rates remain the same, if you do nothing your account balance will be higher from all of your contributions and earnings and you’ll be in a higher tax bracket. Then you’re forced to take money out and the taxes are not in your control.
The key is to control the taxes you pay. You say I’m in a higher rate now, that’s a myth that you’ll be in a lower tax bracket in retirement. The reason I say it is a myth for most people is because those with the largest balances and incomes think they’ll be in a lower bracket because they won’t have W-2 income. That may be true, but if you do nothing, that IRA is growing and going to grow and grow and then you’ll be forced to take that money out (at age 73 if you have RMDs).
Once you retire, your deductions get lower, you generally don’t have as many credits. You don’t have the benefits of dependent children, you probably paid off your mortgage, you don’t have the deduction for your IRA or 401(k), and you’re probably taking the standard deduction like most people do.
The only way that it won’t pay off to move to a Roth is if somehow Congress lowers taxes. If that doesn’t happen and tax rates don’t go up, what is the worst-case scenario? You converted and you locked in a 0% rate in the future. People don’t want to pay taxes upfront but the taxes on retirement savings is not if, but when.
MW: You mentioned using Roth accounts instead of traditional, but what about in the instances when employees don’t have a Roth 401(k) option at work?
Slott: Well they can do their own Roth [IRA], but then they’re subject to income limits. They can do a regular 401(k) at work, that’s their only option if they want to put a lot of money away. There are income limits for Roth accounts and contributions, not conversions.
MW: Roth earning limits are an obstacle that comes to mind. What can or should people do in the times when they can’t contribute directly to a Roth account?
Slott: If there are no income limits from conversions — we’re only talking about contributions — they can convert to Roth. There is no limit to how much they can convert or how much they make. If they want to contribute to a Roth even though their income is too high, they can do a backdoor Roth where you make a contribution to a nondeductible IRA and then convert that. You end up in the same place.
MW: Is there anything else you think retirement savers should know?
Slott: At least consider it because you have low rates now. Rates are on sale. Nobody likes to pay taxes upfront but the last thing you want in retirement is to be worrying about taxes.
(This interview was edited for clarity and length.)
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