Roths (3/27/25)
Why my husband and I contribute all of our retirement savings to Roth
Before we jump in this week, I have a 1 question quiz for you….
Couple A: Ages 65 & 67, recently retired, have saved $3 million in their IRAs & 401ks
Couple B: Ages 65 & 67, recently retired, have saved $2.5 million in their Roth IRAs & 401ks
Which couple will have more money in retirement?
The answer is Couple B. It’s true - $2.5 million in Roth accounts is almost always going to be worth more than $3 million in pre-tax retirement accounts. Think I’ve lost it? We’ll walk through the math below.
But first, let’s take a step back – As you may know, there are two common types of tax treatment for retirement accounts. First, there are pre-tax accounts. This includes traditional IRAs and pre-tax 401(k)s/403(b)s. These accounts provide a tax incentive to entice you to save for your own retirement, and you receive that incentive in the form of a deduction in the year you make the contribution (if you contribute to your employer’s 401k through payroll deduction during 2025, it will reduce your taxable income for the 2025 tax year.) More recently Roth accounts were introduced. You’ve likely heard of Roth IRAs but most 401ks also offer a Roth contribution option. These accounts operate very similarly to their Traditional & pre-tax counterparts, but the primary difference is that you contribute after-tax money, which means there is no incentive in the current year to make the contribution, BUT the money will grow tax-free and withdrawals will be tax-free to you in retirement. TLDR: Traditional provides tax benefit now, tax bill later. Roth provides a tax bill now, tax benefit later.
Some investors, and many advisors, argue that these taxes and benefits net out over time, but based on everything I’ve seen in my career, I’m adamant about saving as much on a Roth basis now for all the following reasons:
Tax rates tend to increase over time. Even if we assume all other things equal, it’s reasonable to expect that the Federal (and state) tax rates we’re paying today will be higher in the future. In this case, a single filer making $100k today pays a lower percentage than a single filer making $100k in the future.
People often incorrectly assume they’ll be in a lower tax bracket when they retire. Social Security, pension income, payments from annuities and withdrawals from your retirement accounts are all taxable income. In this case, a couple making $200k while working may be in the same marginal income tax bracket when retired even though they’re no longer receiving a paycheck.
There’s value to tax diversification. We don’t know what the tax code is going to look like in 12 months, let alone 12 years from now. There is value in having diversification of your accounts from a tax treatment perspective. John and I are lucky enough to receive employer contributions to our 401ks, and employer contributions are made on a pre-tax basis, so even when we put 100% of our contributions in Roth, we’re still accumulating both Roth and Pre-tax dollars simultaneously.
Higher taxable income in retirement can cost you. In addition to the income tax you’ll need to pay on the pre-tax account withdrawals, you may also have to worry about IRMAA, which is a surcharge on Medicare that’s imposed based on your taxable income. In this case, withdrawing from your Traditional IRA can give you higher taxable income which could result in higher premiums on your Medicare parts B & D payments.
I’d rather experience a little pain now for a lot of joy later. Personal preference, but I’m happy to pay a little more in taxes now for the peace of mind that I won’t have to pay them later. I also won’t have the IRS dictating how much we need to withdraw each year when we reach RMD (Required Minimum Distribution) age, and we’ll have more flexibility to withdraw prior to age 59.5, if needed.
So back to the math….I’ve historically told young savers that as a rule of thumb, for every $1million they save in traditional or pre-tax IRAs/401ks, they really only have about $750k since all of that money will be taxable upon withdrawal. Note: if you live in a retiree-friendly state like PA or DE, you don’t have to worry about state income taxes on retirement account withdrawals, at least for today.
It’s also important for me to point out that while there are income limits to make Roth IRA contributions, there are no income limits to contribute to your 401k on a Roth basis. This is a very common misconception and many high-income earners don’t contribute to their employer plans on a Roth basis because they incorrectly assume they’re not eligible.
If you find this compelling and are currently making pre-tax contributions to your employer-sponsored plan, it’s important to remember that changing your contribution election to Roth will lower your net pay. I often recommend shifting just 1-2% of your contribution from pre-tax to Roth at a time, allowing yourself time to get comfortable with the lower net pay over a few pay periods. There are many ways you can make adjustments to your retirement savings elections, feel free to reach out for some personalized suggestions.
For those of you who are self-employed remember that you can contribute to a Roth IRA in addition to a SEP IRA. I think there may need to be a retirement myth-busting edition in the very near future…
I welcome your feedback, questions, and topic requests!
Wishing you good financial health.
