I see all sorts of articles online regarding the benefits of doing $100,000 Roth conversions over a 10-year period, which makes me think that a lot of people aren’t even evaluating income tax brackets. But that’s the best place to start when evaluating whether a Roth conversion makes sense.

Here are three thresholds you need to consider before deciding to do a Roth conversion:

1. Your income tax rate.

This is us looking left. The reality of a Roth conversion is that it’s just a bet that your current tax rate is lower than your future tax rate. If so, you’d rather pay the taxes today. If you’re in the period between retirement and when you start RMDs (required minimum distributions), this can be a pretty safe bet.

I met with a client the other day who is three years out from RMDs. Once both spouses start receiving RMDs, that will push them from the 24% marginal bracket to 32%. So, in doing the conversion calculation, we want to see how much we can convert while staying in the 24% bracket.

2. Your capital gains tax rate.

We are looking right. People talk about capital gains tax rates as though they are 15% for everyone. That is not the case. Evaluating capital gains rates is most important at low income levels and at high income levels.

When your income is very low, a Roth conversion can cause you to go from paying 0% in capital gains to paying 15% on everything. This is an expensive trigger.

Once taxable income crosses above $518,900 (S) or $583,750 (MFJ) for 2024, you jump from 15% to 20%. Less talked about is the 3.8% net investment income tax, which, as it sounds, is a tax on investment income over $200,000 for individuals and $250,000 for a married couple filing jointly.

3. Your Medicare premiums.

Finally, we are going to check the bike lane to ensure we don’t get smacked by an e-bike. Premiums for Medicare Parts B and D are income-adjusted. However, unlike the above income tests, Medicare premiums are determined by gross, not taxable, income. The Part B premiums can increase by as much as $419 per month, per person, based on income. In my experience, this is the one that upsets people the most.

To be clear, you’re not always trying to stay under every threshold. In many situations, it makes sense to pay more in Medicare premiums to avoid a much larger income tax bill down the road.

Evaluating Roth conversions in your situation requires projecting out your future tax rates; i.e., should you even be crossing the road at all? To get a sense of what your rates may look like, you can build out a free plan here.

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You’ve reached the summit of your financial independence journey — now what? 

Without a plan, you might find yourself financially “rim rocked,” as rock climbers stuck with no way out. 

Many assume climbing is about finding a way up and simply taking the same route down, but the truth is that accidents often happen during the descent. A 2006 study found that over half of the 192 deaths above base camp on Mount Everest from 1921 to 2006 occurred on the way down. As mountain climber Eric Arnold, who tragically died descending from his fifth summit, noted, “Two-thirds of the accidents happen on the way down. If you get euphoric and think, ‘I have reached my goal,’ the most dangerous part is still ahead of you.” 

Early Retirement Withdrawal: How to Plan

Achieving FIRE (financial independence, retire early) status is similarly ambitious, and drawing down assets over a much longer period than a traditional retirement brings unique risks. Market conditions and life circumstances can change dramatically over these withdrawal years. One wrong move could prove costly — penalties, taxes, or worse, running out of money. This is reflected in a recent Schroders retirement study that found the major concerns for retiring Americans include: “not knowing how to best generate income and/or draw down assets” and “outliving assets.”

That’s why Brett Spencer, founder and lead advisor of Impact Financial, emphasizes the importance of creating a plan and “diligently monitoring it.”

The FIRE movement is broad, with individuals achieving it in a variety of ways, leading to an array of strategies for spending down assets. While one way is not best for all, many of the dangers on the way down are the same. Here are some strategies for overcoming them.

Sidestepping early withdrawal penalties 

The IRS means well. To discourage premature use of retirement funds, it imposes a 10% tax penalty on early withdrawals from certain retirement plans before age 59 ½. However, this guardrail becomes an obstacle for those who actually save diligently but then retire early.

Fortunately, there are ways to access retirement accounts before age 59 ½ without penalties.

One option is Substantially Equal Periodic Payments (SEPP), also known by its low-budget cyborg movie name, 72(t). This allows penalty-free withdrawals from IRAs or 401(k)s at any age, provided you take a series of substantially equal periodic payments for a minimum of five years or until you turn 59 1⁄2, whichever is longer. Spencer notes that “rules need to be followed for withdrawals to qualify.” For instance, payments must be calculated using one of three IRS-approved methods and cannot be altered once started.

Another possible strategy is a Roth conversion. Here, you transfer traditional IRA or 401(k) funds into a Roth IRA. After five years, these converted funds (but not earnings) can be withdrawn penalty-free and tax-free. This requires careful planning to manage tax implications during the conversion years.

For those with a 401(k) or 403(b) and who aren’t exactly rushing out the door by FIRE standards, the Rule of 55 is another exception. This IRS rule allows individuals who leave their job during or after the year they turn 55 to withdraw funds from their 401(k) without the 10% early withdrawal penalty.

Navigating taxes and investment costs 

A towering figure casting a shadow over the spending down of your assets is none other than Uncle Sam. While you can’t avoid them, you can minimize taxes on account withdrawals.

An early retiree client of Spencer’s illustrates this point. His client structured his FIRE plan with passive income investments, generating more portfolio income than needed. As a result, he paid taxes on unused investment income, which was then re-invested. Spencer says, “We’ve improved this client’s tax efficiency by moving some income investments into his tax-deferred retirement accounts. This way he is more in the driver’s seat on the income he realizes.”

A Roth conversion could also help lower your tax burden, as converted funds can be withdrawn tax-free. However, since you pay taxes on the conversion, the decision depends on whether your tax rate is higher now or when you start withdrawing funds.

For a taxable portfolio, Spencer suggests two strategies: tax loss harvesting and tax gain harvesting.

Tax loss harvesting allows you to sell investments at a loss to offset gains and reduce taxable income. Losses can offset up to $3,000 of ordinary income per year and be carried forward to future years. 

Meanwhile, tax gain harvesting involves realizing gains when you’re in a 0% or low tax bracket. You sell and immediately buy back investments (from a taxable account) that have increased in value to reset the cost basis and take advantage of low capital gains tax rates.

Spencer cautions, “These strategies take a lot of monitoring and careful planning with the right software and tax knowledge.”

Investment costs are another potential drag on your retirement savings. A Vanguard paper even calls the failure to plan for investment fees, such as mutual fund expense ratios, a retirement risk for FIRE investors. After all, investing costs reduce net returns. Therefore, consider investing in lower-cost funds to help you keep more of your returns, increasing the probability of success.

Keeping your portfolio financially sustainable 

Arguably, the biggest challenge among early retirees is portfolio sustainability.

Many FIRE proponents use the famous 4% rule to determine their spending plans. This guideline suggests saving 25 to 30 times your annual spending, then withdrawing 4%, adjusted for inflation, annually. However, the 4% rule is based on a shorter drawdown period of 30 years, not the 50-year period of someone retiring early at 40. Therefore, the 4% guideline might be too generous.

When considering a potentially 50- or 60-year time frame, predicting portfolio sufficiency is difficult. Retirement planning often assumes relatively static spending, but many variables, such as healthcare costs, can dramatically alter your financial needs.

The 4% rule can be a good starting point, providing a target for saving and spending. However, the earlier you retire, the lower your withdrawal percentage may have to be. A safer rate might be around 3% to sustain your portfolio for 50 years. Alternatively, you could save more before reaching FIRE status.

Market downturns also pose a risk to portfolio success when withdrawing funds as prices drop. A dynamic withdrawal rate can help mitigate this risk. With this strategy, you adjust your withdrawal rate based on market conditions: withdraw more during good years and less during bad years, allowing better recovery.

Additionally, Spencer recommends diversification. “A properly diversified portfolio reduces the level of downside potential, which becomes really important once you are living off of your portfolio,” he says. While bonds are a common diversifier, keep in mind they fell alongside stocks in 2022. Therefore, diversify broadly across all asset classes, such as international securities.

Planning is the ultimate lifeline  

A noticeable feature of the FIRE community, evident in blogs and Reddit forums, is a deep commitment to planning. Some manage their finances and retirement planning on their own, which is possible but challenging. Given the potential pitfalls, working with a financial advisor may benefit most.

Spencer points out: “While the thought of retiring early can be very attractive, it is very important to plan and stress test your plan.” Advisors can use simulation models to assess the success rate of your portfolio under various scenarios. While not a guarantee, it provides a good idea of your plan’s sustainability and strength.

Ultimately, the potential dangers should not deter those inspired to retire sooner rather than later. 

Achieving financial independence, even in the most aggressive scenarios, typically takes about a decade or more. This is enough time to learn, grow and adjust strategies, as many FIRE advocates do.

As Beat writer and outdoor enthusiast Jack Kerouac wrote, “Because in the end, you won’t remember the time you spent working in an office or mowing the lawn. Climb that goddamn mountain.”

Read More

• 401(k) Withdrawal Penalty Rule Changes for 2024
• A 10-Year Checklist for Retirement Planning
• How to Retire Early in Six Steps
• How to Retire Early by 50

Various techniques and strategies can help you maximize your retirement savings. You might be familiar with some basic concepts or common methods, but many less obvious tactics may significantly improve your plans. These can vary from adjusting investment portfolios to taking advantage of tax-saving methods. A thoughtful and strategic plan can greatly impact your retirement savings.

1. Take the company match.

There are usually two ways you can contribute to your 401(k): what you contribute yourself and, if available, the match from your employer. If you are not participating in your company match, you are leaving free money on the table. I tell my clients it’s similar to taking a voluntary pay cut and most of us would not want to do that. Unfortunately, despite this benefit, many Americans are missing out. As many as one in four couples fail to take full advantage of matching 401(k) contributions from their employer.

A company match isn’t only good for the employee, it’s good for the company as well. Employees who invest in their future through their 401(k) plan may be less likely to move on to other companies which reduces turnover. Ideally, companies want employees to keep growing their 401(k) in the same place for as long as possible.

I recommend contributing 10% to 15% of every paycheck to your 401(k). If you can’t manage that, you should be contributing at least enough to get the company match.

2. Pay yourself first.

Whenever you get a little extra money, whether it’s a tax refund or a raise at work, it’s tempting to splurge on something fun for yourself. You deserve it! However, you might consider putting at least some of that money toward your financial future first. What does this look like? From the amount of money you make each month, take a look at how much of that you are putting into a savings account. Can you increase that amount? Even an extra $10 per paycheck can make a big difference over the span of your career. You want to ensure you have enough money in your savings account to cover any unexpected emergencies.

You could also consider opening another retirement account such as Roth IRA. This can have a big impact on your overall tax situation in the future. In contrast to a traditional IRA, anything you put into a Roth IRA comes from after-tax dollars. While you don’t get an immediate tax deduction, earnings grow tax-free and withdrawals are tax-free in retirement.

3. Leverage your catch-up contributions.

Catch-up contributions are among the most valuable tools to help boost retirement savings. These are additional contributions allowed beyond the normal limits that retirees can contribute to their accounts. These are especially vital for those nearing retirement.

To qualify for these catch-up contributions, you must be 50 years or older during the calendar year you want to start taking advantage of this added benefit. Catch-up contributions apply to many different accounts like a 401(k), 403(b), 457(b) and a SIMPLE IRA. However, the amount you can contribute depends on the type of account. For a 401(k) or a 403(b), catch-up contributions are limited to $7,500. The maximum catch-up contribution for an IRA is $1,000.

Catch-up contributions can also be made to Roth IRA accounts. You can put it all towards your Roth or split the money between that account and your traditional 401(k).

Adults have spent all of their lives paying for children, a house, or both, and now that they are older most can afford to put more money away for retirement, which is what makes catch-up contributions so valuable.

With Americans living longer than ever before, you must take a closer look at your retirement accounts and adjust accordingly to help make your savings last. If you are serious about retiring and living comfortably, make sure you are saving as much as you can while still earning a paycheck. Whether you are close to retirement or years away, it’s never too late to optimize your retirement savings.

Drake & Associates is an independent investment advisory firm registered with the U.S. Securities & Exchange Commission. This is prepared for informational purposes only. It does not address specific investment objectives, or the financial situation and the particular needs of any person who may view this report. Neither the information nor any opinion expressed it so be construed as solicitation to buy or sell a security of personalized investment, tax, or legal advice. The information cited is believed to be from reliable sources, Drake & Associates assumes no obligation to update this information, or to advise on further development relating to it. Past performance is not indicative of future results. Registration as an investment adviser does not imply a certain level of skill or training.

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For example, if you and your spouse have $1 million in retirement savings tucked away in traditional IRAs, 401(k)s or 403(b)s, your nest egg is likely to be worth $760,000 at the 24% marginal federal tax bracket.

Combine the bite that federal taxes will take out of your retirement savings with the potential additional hit of state and local income taxes and inflation, and you may already be seeing your retirement goals getting harder to reach.

Why taxes hurt in retirement

Taxes have the potential to hit you hard in retirement due to the way the retirement savings and tax systems are set up. If you are a Baby Boomer or Gen Xer, you’ve spent most of your life saving within traditional retirement savings vehicles because that’s all that was available for many decades. And even though Roth IRAs and Roth 401(k)s have been around for a while, they aren’t nearly as widely used as traditional IRAs, 401(k)s and 403(b)s.

The tax deductions that traditional retirement savings vehicles offer upon contribution are popular, which is one reason why contributions into Roth accounts lag behind traditional accounts. The downside of those deductions means that taxes must be paid when you withdraw your appreciated savings in retirement.

And those withdrawals are not optional. When you turn 73 — or 75, if you were born in 1960 or later — you must take what is known as required minimum distributions (RMDs) each year based on your life expectancy as calculated by the IRS. It doesn’t matter if you don’t need the money for your living expenses — you must take RMDs or face IRS penalties.

You may need to withdraw more than the RMDs required to fund your standard of living in retirement, which means — you guessed it — more taxes.

These taxes can have a cascading effect in retirement. Not only do they reduce the amount of assets you have to spend on maintaining your lifestyle and all the potential health care expenses that retirement brings, but they can also increase other costs, such as the tax on your Social Security benefits and the amount you pay in Medicare premiums.

If you are married and have a combined income of more than $32,000 a year in retirement, 85% of your Social Security benefits will be taxed; if you are single and your combined income exceeds $25,000, that same tax rate applies. Combined income includes your adjusted gross income from your federal tax return, tax-exempt interest and half of your Social Security benefits.

Because Medicare premiums are income-based, as your taxable retirement income rises — through a combination of your Social Security benefits, RMDs, other withdrawals from traditional IRAs and any other sources of income, such as rent from rental properties or Airbnbs, an annuity, taxable interest and dividend income or a defined benefit pension — your Medicare premiums may increase.

If you are married and your modified adjusted gross income is less than or equal to $206,000 a year, your total individual Medicare Part B coverage is $174 a month. If your income jumps to more than $206,000 but less than $258,000, your monthly premiums will increase to $244.60. In 2024, Medicare Part B premiums top out at $594 for couples with modified adjusted gross income of greater than or equal to $750,000 a year.

There is also the potential that taxes could increase during your retirement. It’s no secret that the U.S. budget deficit is rising at a time when spending on entitlements such as Social Security, Medicare and Medicaid is also rising. That means you could be on the hook for an unknown higher amount of taxes at some point during your retirement.

Finally, there’s the fact that you’re usually living on a fixed income in retirement. When you’re working, there’s always the potential to make more money — but when you’re retired, what you have saved is all you are ever going to have.

Fortunately, there are three steps you can take to help mitigate your taxes in retirement, including converting traditional IRA assets to a Roth IRA, contributing to a Roth IRA or 401(k) if you are still working or utilizing tax-advantaged annuities or certain cash value life insurance policies.

Step 1: Convert part of your traditional IRA to a Roth IRA.

When you convert all or part of your traditional IRA to a Roth IRA, you pay taxes now so that you won’t have to pay taxes in the future or be subject to RMDs. While that can seem painful, if you’ve got the cash available elsewhere, you will be paying taxes now so you can avoid paying more taxes later. It’s important not to pay taxes with money you withdraw from your traditional IRA, because that will just increase your tax bill.

It’s important to approach this process intelligently, so you should speak to a tax adviser or accountant about how much you are likely to earn in the tax year you want to convert and how much “room” there is in that tax bracket to potentially convert some of your traditional IRA.

For example, if you are in the 24% tax bracket and you are married filing jointly with a taxable income of $250,000, you have $133,900 of “room” in the tax bracket before you would hit the next bracket, which is 32%. That means you would want to convert less than that amount to avoid kicking yourself into a higher tax bracket.

If you chose to convert $120,000 at the 24% federal rate, you would owe $28,880 in federal taxes and would also owe state taxes if you live in a state with a state income tax, although your specific tax bill will depend on your individual tax situation. Roths are subject to other rules that you should discuss with your tax adviser.

Ideally, you would work with your accountant to create a strategy over a number of years to gradually convert all of your traditional retirement assets to a Roth, while keeping yourself from being kicked into a higher tax bracket. (For more about this topic, see the article Roth Conversions: Convert Everything at Once or as You Go?)

Step 2: Contribute to a Roth 401(k) at work.

Nearly 90% of employers who offer employees a 401(k) account also offered the Roth 401(k)in 2023. By switching your contributions from a traditional 401(k) to a Roth 401(k), you will lose the immediate tax deduction that you would have otherwise received, but you will then reap the benefits in retirement.

You will also continue to reap the benefits of any employer match that you are currently getting by contributing to your company-sponsored retirement account. You will also be creating tax diversification within your retirement assets, which will give you more choices in retirement about how to take the tax hit from traditional retirement accounts.

Imagine a retirement free from at least some RMDs and taxes — that is what ongoing contributions to a Roth 401(k) or 403(b) will get you.

Step 3: Leverage life insurance and annuities.

If you don’t have money outside of a traditional IRA to pay conversion taxes but still want to minimize your taxes in retirement, or exceed the earnings limitations for a Roth account, don’t fret. You can take advantage of specific types of annuities and life insurance to get the job done.

You can purchase whole life insurance and use the cash value to pay the taxes on a series of conversions over time with a goal of converting all of your traditional IRA assets to a Roth. If you die before the full conversion of your traditional IRA assets occurs, your heirs can use the life insurance to pay the taxes that are due within 10 years of inheriting a traditional IRA.

The second strategy is to purchase a bonus annuity, which is a type of annuity contract that provides an upfront bonus upon purchase. The bonus increases your account value. You can then make partially taxable withdrawals from that annuity to pay for the taxes due on a Roth conversion.

A final word

Minimizing your taxes with a well-thought-out strategy is a gateway to a more confident retirement. It’s how you can potentially have the lifestyle you want, while paying as little in taxes as possible.

Licensed Insurance Professional. This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice.

The information contained herein is based on our understanding of current tax law. The tax and legislative information may be subject to change and different interpretations. We recommend that you seek professional tax advice for applicability to your personal situation.

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Kelly earned it — she put in the time — but she also acknowledges she couldn’t have done it alone. Together, we had several conversations on how to maximize the plans her company offered. Those plans turned out to be the cornerstone of her retirement nest egg. If you’re like Kelly, working in Corporate America and wondering how to get the most out of what your company offers, here are some of the things that worked for Kelly and may work for you, too.

401(k)/403(b) retirement plans

Workplace retirement plans like 401(k)s or 403(b)s are great places to save. There are many advantages, such as tax-deferred investment earnings, and there may be a company match, which sweetens the deal even more. For 2024, you can contribute $23,000 per year to a 401(k), with an additional $7,500 if you are older than 50, for a total of $30,000.

We advised Kelly to make pre-tax contributions since the tax deduction is more valuable at higher incomes. We continued with pre-tax contributions for several years. Finally, later in her career, we switched back to all Roth 401(k) contributions. We did this because, over her long career, she built up substantial pre-tax savings in her 401(k), and we wanted to create more tax-free Roth withdrawals in retirement.

We also directed her employer match to go into the Roth account, something new under the SECURE 2.0 Act. There is no tax deduction for Roth 401(k) contributions. However, qualified withdrawals are income tax-free.

Kelly’s plan also allows for an “after-tax” contribution, which is an additional contribution above the $23,000 pre-tax or Roth. The IRS limit for employer and employee contributions to a 401(k) is $66,000, so if your plan allows for it, you may be able to save more than the traditional $23,000 limit, like Kelly. The kicker is “after-tax” contributions can be transferred into a Roth IRA, if the plan allows for it — we call this the “mega-backdoor Roth IRA.” The additional after-tax contributions Kelly made in her later years helped accelerate her Roth savings. It’s best to verify with your 401(k) administrator if after-tax transfers are permissible.

All in all, she finished her career with a healthy balance of Roth and regular contributions. The idea is when she needs money in retirement from her 401(k), she will tap the regular contributions first, which are fully taxable, but stop short of withdrawing more if it pushes her income into the next bracket. At that point, if she needs more money, she will use the Roth accounts.

Deferred compensation

Kelly’s company offered a deferred compensation plan, which is a way to save a part of her bonus before taxes to be paid out later. The advantage is she pays lower income taxes today. The deferred bonus can be invested in mutual funds, and the earnings accumulate tax-deferred, another advantage.

I advised Kelly to participate in her company’s deferred compensation plan with a few caveats. Her plan allows for a lump-sum payment at the time of retirement or in a payment over a number of years. I advised her to schedule a payout of the deferred bonus for not less than 10 years. This was to avoid the state source tax. Generally, deferred compensation is taxed in the state where the wages were earned, unless the payments are made over 10 years or more, then it is taxed in the state of residence. Since Kelly was working in New York and wanted to retire to Florida, this was a no-brainer for her, as Florida has no state income tax, and New York does. Under the not-less-than-10-year rule, the deferred payment is taxed in Florida, not New York.

The lump-sum payment at retirement didn’t really make sense for her either, since that would be included in her final year of compensation and put her in a very high tax bracket. And since she was also retiring two years prior to 65, the deferred compensation payment would negatively affect her Medicare premiums, since they are based on income.

There are risks to using deferred compensation. The money deferred is usually locked up for a certain period of time. The investment is also subject to credit risk — if the company goes bankrupt, it would use the funds to satisfy creditors. These are risks that have to be considered and managed, such as limiting their use or having a meaningful emergency savings fund.

Company stock

Kelly received a part of her bonus in company stock. She received restricted stock (RSUs) that vested over three years. After three years, assuming she was still employed with the company, she could do what she wanted with the stock — keep it, sell it, gift it to charity. I advised her to sell her stock as it vested and diversify into a broader portfolio. But she was reluctant and held on to her stock for many years.

Luckily, the stock did well, but unluckily this created a large tax problem for Kelly if she wanted to sell — there would be a capital gains tax due. A few years prior to her retirement, we devised a three-pronged plan to minimize her company stock exposure, without incurring a tax on the sale.

First, we started an aggressive tax-loss harvesting strategy in her other portfolio positions. We were able to book losses for her in both up and down years in the stock market. The IRS allows us to net our investment gains against our losses. She didn’t need the losses now, but we carried them forward on her federal tax return to be used in the future. The idea is to offset the gains realized from selling her company stock with the losses that we banked from prior years. We would wait till retirement to sell the stock, as she would be in a lower tax bracket then.

Since charity is important to Kelly, there are many ways she can donate her company stock. We started contributing some of her low-basis highly appreciated company stock to a donor-advised fund (DAF), which is an account used to help facilitate donations. While Kelly was working and in a high tax bracket was a good time to make a sizable contribution to the DAF. Gifting stock to a DAF is not a taxable event, so she is able to reduce her exposure in the stock and leave her other cash and diversified investments intact.

Finally, we employed a staged sale, which is a fancy way of saying we delayed selling her employer stock until she is in a lower capital gains tax bracket. There are three different tax rates for capital gains in 2024: 0%, 15% and 20%. Your rate depends on your taxable income.

As a single filer, most years Kelly was paying the 20% capital gains rate. However, some years where she deferred a sizable portion of her bonus into the company deferred compensation plan, she dropped to the 15% cap gains rate. In retirement, she should be in the 15% capital gains bracket more consistently.

The key is to know where you fall on the cap gains rate table and see if there are strategies, like using deferred compensation, charitable contributions or delaying to low-income years, to sell long-term highly appreciated stock.

As you can see, there is much to consider when it comes to maximizing company savings and investment plans. But as Kelly can attest, it is worth the work. Over a long employment, I have seen many retire with large sums in their plans. Each plan is unique, so I suggest starting by reading the plan booklet. I also suggest talking to those already retired at the company to learn from their experience.

Finally, a qualified financial or tax professional with knowledge of company plans and benefits can lend a valuable second set of eyes. As I always tell new clients, you only want to retire once, it’s best to get it right the first time.

To schedule your complimentary company plan review with the author, make an appointment with him here.

Michael Aloi, CFP is an independent financial advisor with 25 years of experience in helping clients achieve their financial goals. He works with clients throughout the United States. For more information, please visit www.michaelaloi.com.

Investment advisory and financial planning services are offered through Summit Financial LLC, an SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666.

This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is not a guarantee of future results.

The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Links to third-party websites are provided for your convenience and informational purposes only. Summit is not responsible for the information contained on third-party websites. The Summit financial planning design team admitted attorneys and/or CPAs, who act exclusively in a non-representative capacity with respect to Summit’s clients. Neither they nor Summit provide tax or legal advice to clients. Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local taxes.

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Both 401(k)s are “great retirement savings vehicles,” says Nilay Gandhi, a senior wealth advisor at Vanguard.

But which one is right for you?

Roth 401(k) vs. 401(k)

Let’s start with what the two 401(k)s have in common. Contributions to both traditional and Roth 401(k)s — plus any gains you earn — grow tax-free. Both types of 401(k)s are also eligible for employer matching contributions. The contribution limits are also the same. In 2024, you can contribute $23,000 and savers 50-and-older can save up to $30,500.

The big difference between the two types of 401(k)s, though, is their tax treatment – or when you pay taxes to the IRS. With a traditional 401(k) you postpone taxes to a later date, whereas with the Roth 401(k) you pay the taxes upfront.

“It’s a tradeoff,” said Rob Williams, managing director of financial planning for Charles Schwab. “You’re either taxed upfront or taxed when you withdraw the money.” (The IRS allows penalty-free withdrawals from both traditional 401(k)s and Roth 401(k)s after age 59 ½.)

Differences between Roth and traditional 401(k)s

Traditional 401(k)s are funded with pre-tax dollars deducted from your paycheck, netting you an immediate tax break. “If you put money in a traditional 401(k), that income is not included in your taxes,” said Williams. “It’s an upfront tax benefit.” So, if you earn $100,000 and you contribute $10,000 to your 401(k) this year, your taxable income will fall to $90,000. But there’s no free lunch: you’ll pay income taxes at your ordinary income rate when you withdraw the money in retirement.

In contrast, Roth 401(k)s are funded with dollars that have already been taxed. The power of a Roth 401(k), though, is you can make tax-free withdrawals in retirement. And while Roth 401(k)s, which are a close relative of the Roth IRA, tend to be less frequently used than traditional 401(k)s, nearly all (94.5%) of 401(k) plans managed by Fidelity Investments offer a Roth 401(k) option. However, just 15% of Fidelity 401(k) participants contribute to a Roth IRA.

How to choose

Ok, so how do you weigh the two choices? What key factors should you be looking at?

When deciding between a traditional vs. Roth 401(k), you’ll need to identify your current tax rate and guesstimate your potential tax rate in retirement. Other factors that could impact your decision include what your income will look like in retirement, your cash flow situation during your saving years, whether you’re expecting a big inheritance that can put you in a higher tax bracket later in life, and how long you’ve had your Roth 401(k). (The last point is key for those who choose the Roth 401(k) option later in life. The reason? You won’t be eligible for a penalty-free qualified withdrawal until you’ve had the account open at least five years.)

The most critical piece of information, though, relates to your personal tax situation, says Gandhi. “Do you believe you will be in a higher or lower tax bracket in the future (e.g., during retirement) than where you’re at today?” said Gandhi.

The reason the answer to that question is so crucial is because of the different tax treatments of a traditional vs. a Roth 401(k). 

The rule of thumb is if you think you’ll be in a lower tax bracket in retirement than you are now, then a traditional 401(k) makes more sense. Why? You’ll pay less taxes on your 401(k) withdrawals in retirement. Plus, you’ll enjoy a tax deduction in the here and now when tax rates are higher.

In contrast, if you believe your tax bracket will be higher in retirement (which is often the case for younger 401(k) savers who earn smaller salaries or those who think Congress will boost tax rates in the future), then a Roth 401(k) is the way to go. The reason: Since you don’t pay taxes on Roth 401(k) withdrawals, you’re better able to minimize taxes on your other forms of income and avoid jumping up to a higher tax bracket.

“If you’re in the highest 37% tax bracket today and you think you’re going to be in the 22% tax bracket when you retire, it could be advantageous to go with the pre-tax traditional 401(k) today,” said Gandhi. In contrast, if you’re in a 22% tax bracket today but think you’ll be in a higher one in the future, then it can make sense to do a Roth 401(k).

(Of course, no one knows for sure where tax rates will be in the future, but it’s never a bad idea to assume taxes will be higher, not lower down the road.)

Tip: To pinpoint what tax bracket you’re in now, review your latest tax return to determine your current taxable income and see where you fall by comparing it to the IRS tax brackets for 2024. You can find this information on the IRS website.

How to RMDs differ?

There’s another advantage of a Roth 401(k). Starting this year, thanks to the SECURE 2.0 Act, you no longer must take required minimum distributions (RMDs) from Roth 401(k)s during your lifetime. Savers in traditional 401(k)s, however, are subject to RMDs. Required minimum distributions are minimum amounts that IRA and retirement plan account owners must withdraw annually starting with the year they reach age 72 (73 if you reach age 72 after Dec. 31, 2022).

“It gives (the Roth 401(k) account holder) a lot more flexibility because you’re not forced to take withdrawals,” said Williams.

Not having to take money out of a Roth 401(k) has multiple benefits. One is being able to keep all your money invested for longer to boost your account’s growth potential. (Traditional 401(k) users, in contrast, are forced to withdraw money even if they don’t need to, which boosts their taxable income and reduces their account balance.)

Having some of your retirement savings in a Roth 401(k) also allows you to benefit from “tax diversification.” If you have multiple sources of income in retirement, from say a traditional 401(k), taxable brokerage accounts, cash savings, and a Roth 401(k), you have more flexibility in deciding which account to withdraw from to minimize your tax burden. Say you need $50,000 for a down payment on a vacation home or a new electric car. Yanking the entire amount out of a traditional 401(k) will create $50,000 more in taxable income that could push you up in a higher tax bracket. However, if you have ample savings in a Roth 401(k), you could take your RMDs and then pull the rest of the money you need from the Roth 401(k) to make your large purchase more tax-efficient, said Williams.

“We call it tax bracket harvesting,” said Williams, referring to the strategy of pulling from more tax-efficient accounts to avoid generating additional income that could boost your tax bill. “What you’re doing is diversifying tax risk and providing yourself more flexibility when you get to retirement.”

Since future tax rates are tough to predict, there’s nothing to say you can’t hedge your bets by contributing to both a traditional and Roth 401(k), adds Williams. If you go this route, you still must adhere to the maximum contribution limits imposed by the IRS. You can’t, for example, sock away $23,000 in a traditional 401(k) and another $23,000 in a Roth 401(k).

In some cases, deciding between a traditional vs. a Roth 401(k) can come down to a simple personal finance concept called cash flow, adds Gandhi. If your monthly budget is tight, the traditional 401(k) might be a better fit as the upfront tax deduction you get from making pre-tax contributions means you’ll have more left in your paycheck after funding your account than if you took the same amount out after-tax to invest in a Roth 401(k).

Read More

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But even the most responsible of us can face a financial emergency and have thought about tapping into savings stashed in a 401(k). Maybe you have unexpected medical bills after an accident or hurricane damage to your home. Or maybe you need funds to pursue an exciting new opportunity, like buying a home, starting a business or going back to school.

Either way, if you need assets from your 401(k) now, here are some ways to minimize penalties — and a few other (potentially better) options to get you through financial straits.

Options for 401(k) early withdrawals

Your reason for disbursing money from your 401(k) and the way you go about it can make a big difference in the taxes, penalties and interest rates you’ll pay. Some of the most common avenues for avoiding the 10% early withdrawal penalty include:

Taking a hardship withdrawal. Most 401(k) plans allow withdrawals in a period of dire financial need. This typically involves difficulties stemming from medical expenses, costs relating to the purchase of your principal residence, tuition and related educational fees or expenses, payments necessary to prevent eviction from or foreclosure on your principal residence, burial or funeral expenses, certain repair costs for your principal residence and any losses or expenses incurred by a federally designated disaster (such as a hurricane, wildfire or industrial accident). Your 401(k) website will have more information, including withdrawal amounts, terms and conditions.

Remember: While this type of disbursement isn’t subject to the usual 10% penalty, it is subject to income taxes.

Obtaining a loan. If you need money now but are confident you can pay it back later, taking a loan from your 401(k) is an option. Most plans allow loans of up to $50,000 for first-time borrowers, paid back, including interest on the loan, into the plan over a period of up to five years.

The interest rates for these loans can hover around 9%, but will vary based on current prime interest rate plus 1% — an attractive option when rates for a personal loan can be higher, particularly for those with less-than-stellar credit. Notably, these loans are not subject to penalties or income taxes.

Structuring periodic payments. Though less common, you can also elect to take a 72(t) distribution, also known as a substantially equal periodic payment, from your 401(k) plan. These can come in three forms: required minimum distributions (RMDs), fixed amortization or fixed annuitization. While you can leverage this option at any age, they are dependent on life expectancy factors, and you should work with your financial adviser and/or CPA to select the best method for you.

While the 10% early withdrawal penalty doesn’t apply in this case, these distributions would be subject to income tax. They also come with some drawbacks: You cannot take the full amount in a lump sum, have little flexibility once the initial terms are set and must continue with payments for either five years or until age 59½ (whichever comes first). Still, these can be useful for those who want to retire early.

Special circumstances. Outside of immediate hardship, there are other special situations that will allow you to draw on your 401(k) early without a penalty. Examples include disability, terminal illness or recently giving birth to or adopting a child. Similarly, if you need to make payments in the course of a divorce, you can access a lump sum without penalty (though it may be subject to income taxes depending on the terms of your qualified domestic relations order).

With all options, keep in mind that the rules and requirements will vary with your specific plan, so be sure to examine those carefully before making any decisions.

Alternatives to a 401(k) withdrawal

Since drawing on your 401(k) can hurt your retirement savings — both in reduced principal and missed market returns — you should explore other ways to access cash depending on your financial situation.

Some alternatives include:

Drawing on home equity. If you own your home, establishing a home equity line of credit can allow you to cover your expenses or consolidate debt from other loans with a better interest rate (the current average for a home equity loan is around 9%). By borrowing against your home’s value, you can get through a financial rough patch and repay what you borrowed when you’re more financially stable. But there are many important considerations associated with drawing on home equity, and you should consult a qualified mortgage professional to learn more.

Leveraging life insurance. If you have a cash value life insurance policy, you may be able to withdraw contributions from or borrow against the cash value account for short-term funds. Interest rates for repaying this type of loan can vary considerably.

However, a word of caution: Loans and withdrawals from a life insurance policy reduce the policy’s cash value and death benefit and increase the chance that the policy may lapse. If the policy lapses, matures, is surrendered or becomes a modified endowment, the loan balance at such time would generally be viewed as distributed and taxable under the general rules for distributions of policy cash values. For variable life insurance policies, withdrawing from your policy’s cash value account can permanently reduce the value of your policy in the future, as you would lose out on the market return potential on the money that’s been withdrawn — meaning your beneficiaries may also receive less when the policy’s death benefit, which is the primary purpose of all life insurance, is paid out.

Consider your options carefully

Drawing on your 401(k), life insurance policy or home equity can be a lifeline when money is tight and you’re faced with a financial emergency.

But it can also mean borrowing against your future to fund your present — with serious financial implications. Before you decide to withdraw or take out a loan, ensure you understand the conditions, penalties and interest rates that will apply so that you can build a better financial future for yourself and your family.

This article, which has been written by an outside source and is provided as a courtesy by Stephen B. Dunbar III, JD, CLU, Executive Vice President of the Georgia Alabama Gulf Coast Branch of Equitable Advisors, LLC, does not offer or constitute, and should not be relied upon, as financial, investment, tax, legal, mortgage/home equity loan advice. Your unique needs, goals and circumstances require the individualized attention of your own tax, legal, financial, and mortgage /home equity loan professionals whose advice and services will prevail over any information provided in this article. Equitable Advisors, LLC and its affiliates do not provide tax or legal advice or services Stephen B. Dunbar III offers securities through Equitable Advisors, LLC (NY, NY 212-314-4600), member FINRA, SIPC (Equitable Financial Advisors in MI & TN), offers investment advisory products and services through Equitable Advisors, LLC, an SEC-registered investment advisor, and offers annuity and insurance products through Equitable Network, LLC (Equitable Network Insurance Agency of California, LLC). Financial Professionals may transact business and/or respond to inquiries only in state(s) in which they are properly qualified. AGE-6603227.1 (05/24)(exp.05/26)

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An early withdrawal is typically subject to ordinary income tax and a tax penalty. However, there is some good news: as of January 1 this year, changes to the retirement plan withdrawal rules have taken effect. The SECURE 2.0 Act allows penalty-free withdrawals to address personal emergencies and domestic violence.

Here’s more of what you need to know about how your emergency retirement account withdrawal might impact your tax return.

IRS rules on 401(k) early withdrawals

Of course, you can withdraw money from your retirement account. However, for those under age 59½, early withdrawals are generally subject to regular federal income tax and a 10% additional tax penalty. That has made them less attractive options for many facing an unexpected financial crisis.

However, as of 2024, a new provision allows individuals to make penalty-free annual withdrawals to cover personal emergency expenses. 

• Specifically, you can withdraw up to $1,000 from your qualified plan (e.g., 401(k), 403(b), 457(b)) or IRA (including SEP, Simple IRA) once each calendar year without penalty.
• You will still have to pay ordinary income taxes on the withdrawal.
• However, if you choose not to repay the distribution within three years, you generally cannot take another personal expense distribution during that period.

You only need to self-certify in writing to your employer that the withdrawal is necessary due to an emergency. 

What’s an emergency expense? The IRS recently clarified that an emergency personal expense distribution is “made from an applicable eligible retirement plan to meet unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses.”  

While many emergency or personal expenses can be covered with a personal expense distribution, the IRS provides some general examples. These examples include medical expenses, financial needs related to car repairs, foreclosure, an accident, or a funeral or burial.

It’s good to seek guidance from a trusted tax professional if you are uncertain about taking a personal expense distribution or your plan doesn’t participate.

Domestic abuse distributions SECURE 2.0

Revised retirement account withdrawal rules also offer tax relief to victims of domestic abuse who find themselves in need of financial assistance.

• If you are under the age of 59½ and have been a victim of domestic abuse you can currently withdraw up to $10,000 from a qualified retirement account (or 50% of your vested account balance, whichever is less) without incurring the usual 10% tax penalty. 
• However, you generally still pay ordinary income taxes on the withdrawal.
• This domestic abuse victim distribution can be taken within a year following a domestic abuse incident (any date a person has been the victim of domestic abuse by a spouse or domestic partner). You can self-certify that the abuse occurred.
• You have the option to repay the domestic abuse distribution. If you do so within three years, you may be eligible for a refund of taxes paid on the repaid amount.

Note: The IRS considers“domestic abuse” to be “physical, psychological, sexual, emotional, or economic abuse, including efforts to control, isolate, humiliate, or intimidate the victim, or to undermine the victim’s ability to reason independently, including abuse of the victim’s child or another family member living in the household.”  

Taxes on a 401(k) withdrawal

When you withdraw from your retirement savings account, the federal tax you pay depends on several factors including account type, your age, and federal tax bracket. (For example, Roth 401(k) withdrawals are tax-free, since contributions were made with after-tax dollars.)

Under the new rules for domestic abuse and personal expense distributions, as mentioned above, the ordinary income tax you would typically pay won’t be increased by the normal 10% tax penalty. But keep in mind that there’s a possibility your state may tax retirement distributions.

Retirement plan distributions are reported on Form 1099-R. This form typically comes from the retirement plan and shows the amount you received and the taxes withheld. Those amounts are reported on your federal income tax return.

Early withdrawal penalty: Bottom line

These SECURE 2.0 changes could be helpful for those needing to make early emergency withdrawals from a retirement savings account. However, it's important to consider the potential tax and financial effects of accessing retirement savings early.

Evaluate available funding sources and consult with a qualified tax or financial planner to see how they might affect you.

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• Types of Income the IRS Doesn't Tax
• Average 401(k) Balance by Age
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They had done well on their investments, but the rest of their plan had no focus, and they were missing important details. These weren’t mistakes that would cause failure, but they were mistakes that could cost them hundreds of thousands of dollars over the course of their retirement. They needed to understand that when you have saved millions of dollars and enter into retirement, your focus shifts.

A cookie-cutter plan concerned only with saving and growing investments is no longer useful. You now have to consider more sophisticated planning based on taxation and estate plans. For example, people with significant savings often need to know:

• How to fund their lifestyles in the most tax-efficient way now that they no longer have incomes
• Advanced tax strategies like Roth conversions and how much to convert each year in a smart way
• If they need more sophisticated estate planning documents or trusts in place
• How to ensure tax-smart distributions to beneficiaries when they pass

Many of the people who schedule time with us are complete DIYers, as we call them. They love it, and it even seems like a hobby for them. However, many of them end up choosing to work with us for the following four reasons.

1. Advanced tax strategies.

Many DIYers who come to us feel fairly confident on the investment side of things. Although they may not necessarily have the best investment structure in place, their strategies have done well enough. The real concern comes from tax planning and knowing what strategies are out there to save money on taxes. It makes sense that many people do not know how to do this because the rules change so often. If you are not reading the tax code and staying up to date on changes, then you may be missing out on opportunities (this is something we see often with this group.)

It is also, in my mind, the most important financial pillar to plan for, considering taxes will most likely be the biggest expense in retirement. Most of the time, we are able to show DIYers enough value in tax savings and other financial planning guidance to make the fees worthwhile.

2. Lack of knowledge of tax rules and changes.

No one wants to make mistakes with their money or leave money on the table because they’re not able to stay up to speed on ever-changing tax rules. If they do not spend every day studying financial planning, they may not be up to date on everything or aware of all the strategies they are missing. If this is you, you have to ask yourself: How many retirements have you successfully planned? And is it worth trying to DIY something this important when you’ve never done it before? Would you ever work with an adviser who has no experience besides managing their personal investments? That is technically the decision you are making by DIYing your retirement.

3. Delegation.

Those who have saved successfully and are ready to enjoy their retirement are usually more interested in focusing on enjoying their time and not having to worry about reading tax law changes or following investments. For such people, the question is: Will it be worthwhile to pay a fee to an adviser to give you more time and peace of mind?

I am a big fan of delegation in my personal life. I try to delegate everything that someone can do better than me, as well as anything I do not enjoy. The time and money saved from avoiding mistakes is everything to me. I get to do what I love most: spending time with my family, traveling, exercising and working in my business.

A great example of why delegation is important occurred when I once tried to fix a plumbing issue. It took me more than 10 hours. I did not have the tools, so I had to go to the store to buy everything. Then I had to spend more time than an expert because I had not done it before and had to watch YouTube videos to learn what needed to be done. I had to waste my entire weekend. Instead, I can pay a few hundred dollars to a plumber, have no worries and save my time. I like that concept.

4. Assistance for the surviving spouse.

Many of these DIYers do a great job planning their retirements and get many of the key points established. They may be successful on their own, but when they are gone, will their surviving spouse be as capable? More often than not, we find that one side of the marriage is finance-oriented, and the other is not.

Are you confident your spouse will be able to decide how much to convert each year or how to rebalance and make adjustments to the investment portfolio? Will your spouse know which investments to use for income?

The other question to consider is: Do you want to decide who your spouse’s adviser will be, or would you rather your spouse choose? If they do not have as much knowledge about financial planning, then they may not pick the best adviser team to serve them and may not know what to look for when vetting different firms. As we all know, there are advisers out there who do not always do the right thing.

If you are a DIYer and these points don’t apply to you, or maybe you are okay without having a plan for these issues, then you may not have to worry and should continue on. Sometimes, doing it on your own because you enjoy it can be worth missing a few details. At the end of the day, it’s your plan and your choice what the future of your life savings and retirement will look like!

 Here are a couple of videos that may help you on your journey:

• This video will help you decide if you want to continue doing things on your own or seek out help.
• This video will help as you do tax planning on your own.

The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

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Retirement also gives you more command over your money. While you’re working, you have limited control over how often or how much you’re paid, which limits your ability to lower your taxes. But if you’re drawing retirement income from a combination of different types of accounts, you can control not only the amount you withdraw but also the sources of those withdrawals — and that could have a big impact on your taxes now and in the future. 

Conventional wisdom has long held that retirees should take money from their taxable brokerage accounts first, followed by traditional IRAs and other tax-deferred accounts, with Roth IRAs and Roth 401(k)s coming last. The logic behind this strategy is that it gives your tax-advantaged accounts more time to grow. Money in tax-deferred accounts isn’t taxed until you take withdrawals, and withdrawals from a Roth are tax-free as long as you’re 59 1/2 or older and have owned the account for at least five years. 

But in recent years, some retirement experts have questioned whether this is the most effective way to lower taxes on your retirement income and preserve your savings for your later years. Postponing withdrawals from your tax-deferred accounts could eventually lead to large, taxable required minimum distributions (RMDs currently start at age 73). 

And since those withdrawals are taxed at ordinary income tax rates, which range from 10% to 37%, large distributions could push you into a higher tax bracket and trigger Medicare high-income surcharges, says Wade Pfau, professor of retirement income at the American College of Financial Services and author of Retirement Planning Guidebook: Navigating the Important Decisions for Retirement Success. 

Roger Young, a certified financial planner and thought leadership director for T. Rowe Price, agrees. The conventional withdrawal sequence “bunches a lot of taxable income in the middle period, where pretty much all of your income is taxable,” he says. 

Retirees who have a mix of accounts could generate income more tax-efficiently by withdrawing from a combination of taxable and tax-deferred accounts, as well as making strategic conversions to Roth accounts, while remaining in a low tax bracket, Pfau says. One way to accomplish this goal is to withdraw enough from your taxable accounts to cover spending needs and income taxes. After that, calculate how much you can withdraw from your tax-deferred accounts and convert to a Roth while remaining within your desired tax bracket. 

In 2024, a married couple who files jointly can have up to $94,300 in taxable income and fall within the 12% tax bracket; for singles, the cutoff is $47,150. These thresholds are close to the points at which taxpayers can qualify for a 0% tax rate on long- term capital gains and qualified dividends (assets held for more than a year are subject to rates for long-term gains). In 2024, the 0% rate applies to capital gains and qualified dividends for singles with taxable income up to $47,025 and married couples with joint taxable income up to $94,050. 

Taking strategic withdrawals from a mix of taxable and tax-deferred accounts while remaining within these thresholds provides two benefits. You’ll pay taxes on your tax-deferred withdrawals at a low rate and reduce the size of those accounts, which will shrink your RMDs. You may also qualify for the 0% capital gains rate on income from your taxable accounts. 

Meanwhile, you’ll pay taxes on conversions from a traditional IRA to a Roth at a low rate, which will increase the amount of tax-free income you’ll have available in later years. Ideally, you should use assets from your brokerage or other taxable accounts to pay taxes on the conversions, Pfau says. 

If you postpone Roth conversions until you’ve depleted those accounts, you may have to use funds from your IRA to pay the tax bill. That’s not the end of the world, he says, because you’ll still benefit from having future tax-free income (and if you’re 59 1/2 or older, you won’t pay a 10% early-withdrawal penalty on those distributions). But it reduces the amount of money you’ll be able to invest in the Roth.

Taxes on Social Security

Converting funds in your traditional IRAs to a Roth can help reduce your taxable income later in life because, ideally, a large percentage of your withdrawals will come from your Roth. This will help you avoid what Pfau calls the Social Security “tax torpedo,” which occurs when up to 85% of your benefits are taxed. 

The formula for calculating tax on Social Security benefits is based on what Social Security defines as your provisional income (sometimes referred to as combined income), which is based on half of your Social Security benefits, plus other sources that contribute to your adjusted gross income, including withdrawals from traditional tax-deferred accounts; dividends, interest and capital gains from taxable investment accounts; and interest from municipal bonds. 

If your provisional income ranges from $25,000 to $34,000 for single filers, or $32,000 to $44,000 for joint filers, up to 50% of your benefits will be taxable. If your provisional income is more than $34,000, or $44,000 for joint filers, up to 85% of your benefits will be taxable. 

These thresholds aren’t adjusted for inflation, which means the percentage of retirees who pay taxes on their benefits has increased dramatically since the tax was signed into law more than 30 years ago. More than half of retirees pay taxes on a portion of their Social Security benefits, according to the Center for Retirement Research at Boston College. 

Withdrawals from a Roth aren’t included in your provisional income, so increasing the size of your Roth accounts through strategic conversions can help lower taxes on your benefits. If you’re able to delay filing for Social Security until age 70, which will maximize the amount of your monthly payouts, you’ll have more time to reduce the size of your tax-deferred accounts and convert some of your funds to a Roth, T. Rowe Price’s Young says. 

Charitable giving

If you plan to give funds in your tax-deferred accounts to charity, you may not need to accelerate certain withdrawals as much as you would otherwise. 

One strategy that can reduce your RMDs — and your tax bill — is to make qualified charitable distributions (QCDs), which are donations made directly from your IRA to qualified charities. You can make a QCD as early as age 70 1/2, but when you reach the age at which you’re required to take distributions, the charitable distribution will count toward your RMD. 

Although a QCD isn’t deductible, it will reduce your adjusted gross income, which will in turn reduce the provisional income used to calculate taxes on your Social Security benefits. In 2024, you can donate up to $105,000 directly from your IRA to a qualified charity. 

Alternatively, if you’re worried about giving away money you may need for long-term care or other late-in-life expenses, you can leave funds in your IRA to charity. The charity won’t have to pay taxes on the money, and you can leave more tax-friendly assets to your heirs. But this won’t absolve you from taking RMDs and paying taxes on those withdrawals while you’re still alive. 

Your estate and taxes

Shifting more of your assets to Roth accounts won’t just lower your taxes in your later years. It could also benefit your heirs if they end up inheriting money in those accounts. 

Under the SECURE Act of 2019, most adult children and other non-spouse heirs who inherit a traditional IRA or other tax- deferred account from an owner who died on or after January 1, 2020, have two options: Take a lump sum and pay taxes on the entire amount, or transfer it to an inherited IRA and deplete the account within 10 years of the death of the original owner. 

Depending on whether the original owner was taking RMDs when he or she died, the heirs may also have to take yearly withdrawals based on their life expectancy, which could mean paying taxes during their highest-earning years. (Spouses still have the option of rolling inherited IRAs into their own IRAs.) Because of confusion about the rules, the IRS has waived the RMD requirement for non-spouse heirs the past few years and is doing so again for 2024. 

The 10-year rule also applies to inherited Roth IRAs, but heirs aren’t required to pay taxes on the withdrawals or to take RMDs. That gives them plenty of flexibility, including the ability to wait until year 10 to deplete the account, thereby taking advantage of more than a decade of tax-free growth. 

If you have a large brokerage account with significant appreciation, you may want to consider preserving some of those assets for your heirs. Under current tax law, inherited investments receive a “step-up” in their cost basis to the current fair market value when the original owner dies. If your heirs turn around and sell those investments right away, they won’t pay tax on any gains, no matter how much the investments have increased in value since you purchased them. 

Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.

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