Called to Account

Jonathan Clements

MY FAMILY HAS BEEN regularly visiting a remote corner of southwest England since 1968, when I was five years old. My maternal grandparents retired to the area, and for a while my parents owned a holiday house nearby. It is, to me, the world’s most beautiful place.

Decades ago, while walking the country lanes, I came across the ruins of a church that was under the protection of a group called Friends of Friendless Churches, a name that made me chuckle. Lately, I’ve been thinking we need a similar group in the U.S.—to offer support for traditional, tax-deductible retirement accounts, which also seem to be notably friendless.

In recent years, I’ve seen repeated comments from retirees lamenting the big tax bills they now face as they draw down their traditional 401(k)s and IRAs, and how they wish they’d never funded these accounts. Many are taking evasive action, including converting big chunks of their traditional retirement accounts to Roths, something I’ve also been doing. Still, all the handwringing strikes me as overdone, because it ignores four often-overlooked benefits that traditional 401(k)s and IRAs offer.

Tax-free growth—or better. Roth accounts, which don’t offer an initial tax deduction but do give investors tax-free growth, were introduced in 1998. That means many of today’s retirees had no choice early in their career but to fund traditional retirement accounts, where you get an initial tax deduction but all withdrawals are taxed as ordinary income.

But here’s what folks forget: Tax-deductible retirement accounts can also give you tax-free growth, just like a Roth. If you’re in the same tax bracket when you draw down a tax-deductible retirement account as when you funded it, the initial tax deduction effectively pays for the final tax bill. In fact, if your tax bracket in retirement is lower than it was during your working years, you can come out ahead, making more from the initial tax deduction than you lose to the final tax bill. You can read an explanation of the math here.

One way you can take advantage of a lower tax bracket in retirement: convert part of your traditional IRA to a Roth. I made big Roth conversions in 2022 and 2023, and I’ll probably do another one this year, with a view to shrinking my required minimum distributions once I’m in my 70s.

I’ll need to be more careful starting in 2026, because I’ll be turning age 63 that year. The issue: Boosting my taxable income with Roth conversions could drive up my Medicare premiums once I turn age 65. On top of that, the 2017 income-tax cuts may sunset at year-end 2025. In any case, I don’t want to overdo the Roth conversions—and I certainly wouldn’t want to have everything in Roth accounts—because there are some good reasons to keep a decent sum in traditional retirement accounts.

Filling those lower brackets. Many folks love the idea of paying zero income taxes. They shouldn’t. You don’t want to pay high taxes during your working years and then find yourself paying nothing in retirement. Instead, ideally, you pay a similar tax rate throughout your life. Filling up tax-deductible retirement accounts during your working years and then draining them in retirement can allow you to do just that.

Are you retired with little taxable income? Drawing down your traditional retirement accounts or converting them to a Roth can allow you to take advantage of the 10% and 12% federal tax brackets, which strike me as a bargain. To hit the top of the 12% tax bracket in 2024, a married couple could generate as much as $123,500 in income, after factoring in the standard deduction. What if you had all your money in Roth accounts? You wouldn’t be able to take advantage of these lower brackets, which would be a shame after a career during which you might have paid taxes at 22% or higher.

Giving back. Money in a traditional IRA would also allow you to take advantage of qualified charitable distributions (QCDs) once you reach age 70½. A QCD is one of the most appealing ways to support your favorite causes.

True, you won’t get a tax deduction for your charitable contributions. But the money that goes directly from your IRA to a charity avoids all income taxes, which means your gift is effectively tax-deductible. On top of that, the withdrawal counts toward your required minimum distributions, which these days kick in at age 73, and you can get the tax savings while also taking the standard deduction, a double win not available for regular charitable contributions. In effect, by funding a tax-deductible retirement account and then later making QCDs, you get a handsome tax break during your working years, plus you avoid the tax on all subsequent growth.

What if you’d funded a Roth instead? Sure, you could make a QCD from your Roth. But you wouldn’t be doing the charity any special favor—it doesn’t pay taxes whether the money comes from a Roth or a tax-deductible account. You, on the other hand, should be kicking yourself, because you effectively missed out on a valuable tax break by funding the Roth.

Paying medical costs. Many of us will face steep medical costs later in retirement. If those costs exceed 7.5% of adjusted gross income, they’re deductible on Schedule A. The expenses that qualify for the deduction include many related to long-term care.

Thanks to the deduction for medical costs, you could potentially tap a traditional retirement account and pay little or no tax on your withdrawals. What if you avoided traditional retirement accounts or earlier converted everything to a Roth? The medical deduction could be worthless to you.

The upshot: Most folks should go for tax diversification, funding both traditional and Roth accounts during their working years. And while it’s tempting to make big Roth conversions early in retirement, especially if you find yourself in a low tax bracket, don’t overdo it. In your later years, you may face hefty medical expenses, find yourself in a low tax bracket or want to make QCDs—and, at that juncture, you could put your traditional retirement accounts to good use.

Jonathan Clements is the founder and editor of HumbleDollar. Follow him on X (Twitter) @ClementsMoney and on Facebook, and check out his earlier articles.

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