You need to save for retirement if you want to be financially stable and comfortable in the future, but an expert says you might be doing it all wrong.
401(k) and IRA accounts, each of which comes in both standard and Roth versions, are the two most common ways to save for retirement. When money is taken out of a traditional account, it is taxed because it was put in before taxes. But when money is put into a Roth account after taxes, it grows tax-free and is not taxed when it is taken out. Also, needed minimum distributions do not apply to Roth accounts.
People who earn more money and think they’ll be in a lower tax bracket when they retire may choose a traditional account. People who are just starting out in their jobs and not yet making their highest incomes may choose a Roth account.
Ed Slott doesn’t agree. He says that anyone can have a Roth account at any time. The author is a certified public accountant whose namesake business invests in and analyzes IRAs. The book is called “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 that people who save money will probably have to pay more in taxes if they wait to pay them.
The Tax Cuts and Jobs Act set the current tax rates, which will also end at the end of 2025. It is not yet known what the new rates or bands will be.
Slott says he has seen what happens when you wait before. He found that his client’s income was higher in retirement than during his best earning years because his IRA grew so much and his required minimum distributions were more than the income he had when he was working. This was because his client chose a traditional retirement account during his best earning years. He wasn’t shocked, but his client was.
Slott told MarketWatch how to decide if a Roth account is right for you, what to do if your employer doesn’t offer a Roth 401(k), and how to weigh the pros and cons of a tax bill right now.
MarketWatch: Why did you write this book?
Ed Slott: The tax time bomb that is going off is the most important thing. A lot of people don’t know that the tax is building up in their IRAs and 401(k). That cash hasn’t been charged yet. The deal is that you get tax breaks as you donate. You agree to the withdrawals ahead of time, but like any deal with the devil, there will come a time when you have to pay that money back. What worries me is that taxes will go up in the future. Because of the size of the national debt, Congress may never decide to do anything about it. But if they do decide to act, there will be a turning point. People who have money in an IRA are most likely to have their taxes raised. For Congress, it’s like a big, juicy steak.
M.W.: Do you think people think about this when they give?
Slott: Most people can’t see very well. Even though the market is doing well—well, maybe just the last few days—and has been for a long time, they still check the account amount. The government is owed a lot of that money. It’s risky for them to think that’s their money. Say you have $1 million saved in an IRA or 401(k). You might plan to use that to fund your retirement. You need to pay taxes before you can get that money, but you don’t know what taxes are.
MW: So why should people use standard accounts instead of something like a Roth?
Slott: I’m the only one who thinks that way, but I say that putting money into a standard 401(k) or IRA is pointless because all you’re doing is adding to your tax bill in the future. Take the money out. Switch to a Roth account and build an account that doesn’t pay taxes. With a Roth, you can protect your standard of living in retirement from the damage that taxes can do. Your IRA is a note from the IRS that you owe money on. It’s like having a mortgage on your savings account, but everyone knows what a mortgage is. You look at the account to see how much you’ll owe. You don’t know how much is in a savings account. You did your research before going to the bank to get a mortgage. You asked questions like, “What’s the interest rate?” “Don’t worry about it,” the banker told them. The banker said, “We’ll tell you how much you owe based on when and how much we need it.” That sounds like something no one would want to do.
MW: What about people who are getting close to retirement and might not be able to switch as easily?
Use up all of today’s tax rates, Slott. These rates have never been this low before. When it comes to taxes, I always follow the rule that says I should pay the least amount of money possible. It’s very easy. People don’t like having to pay taxes up front, so they don’t do it.
MW: People who are making a lot of money tend to do better with traditional accounts. How do you find that balance when you’re making more money than you will in the future?
Slott: That is the most important question we get in our trainings. Moving your money from accounts that will be taxed forever to accounts that will never be taxed is what it all means. It’s all a big guess about what the tax rates will be. I think they’ll be higher, but if Congress doesn’t do anything about it and tax rates stay the same, you’ll be in a higher tax bracket because your account amount will be higher from all the money you’ve put in and earned. After that, you have to take money out because you can’t change the taxes.
The important thing is to keep your taxes in check. You say you’re in a higher tax rate now. It’s not true that you’ll be in a lower rate when you leave. These people think they’ll be in a lower tax rate because they won’t have a W-2 income, which is why I say it’s a myth for most people. That may be true, but if you don’t do anything, that IRA will keep growing, and eventually you’ll have to take that money out (if you have RMDs, at age 73).
You usually don’t have as many credits after you leave because your deductions go down. Assuming you paid off your home, you don’t have any dependent children to claim as tax breaks. You’re also probably taking the standard deduction, which is what most people do.
Tax cuts by Congress are the only thing that could make switching to a Roth not worth it. What is the worst thing that could happen if that doesn’t happen and tax rates don’t go up? You moved the money, and now the rate will never go up. People don’t want to pay taxes right away, but the question is not if they will pay taxes, but when.
MW: You said to use Roth accounts instead of traditional ones. What about when workers don’t have access to a Roth 401(k) plan at work?
Slott: They can set up their own Roth IRA, but there are limits on how much they can earn. Any regular 401(k) plan at work is their only choice if they want to save a lot of money. Roth accounts and donations have limits on how much money you can earn, but not conversions.
MW: One problem that comes to mind is the ceiling on Roth earnings. People can’t always put money straight into a Roth account. What should they do instead?
If there are no limits on how much they can earn from conversions—we’re only talking about contributions—they can change it to a Roth. They can turn any amount of money into cash and make too much to count. If they want to put money into a Roth but their income is too high, they can do a “backdoor Roth.” This is when they put money into an IRA that isn’t tax-deductible and then convert it. You stay where you are.
MW: Is there anything else you think people who are saving for retirement should know?
Slott: You should think about it since your rates are low right now. You can get rates now. Taxes are something no one likes to do, but when you retire, the last thing you want to do is think about them.
