Many Americans face a critical question as they plan for retirement: Should I pay taxes on my retirement savings now or later? One common strategy involves investing solely in pre-tax accounts during your working years—such as a traditional IRA or 401(k)—and then converting those funds to a Roth IRA in retirement, when your income may be lower.
This approach can work well in certain scenarios, but it’s not without trade-offs. Below, we break down the potential advantages and disadvantages of this strategy so you can determine if it fits your overall financial plan.
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Potential Advantages of the Pre-Tax Now, Roth Later Strategy
1. Immediate Tax Savings While Working
Contributing to pre-tax accounts reduces your taxable income today. This can help lower your current tax bill and potentially put you in a more favorable tax bracket.
2. Flexibility After Retirement
Once you retire and your income decreases, you may find yourself in a lower tax bracket. This opens the door to convert funds from your traditional IRA or 401(k) to a Roth IRA at a potentially lower tax cost.
3. Long-Term Tax-Free Growth
After you convert to a Roth IRA, future investment earnings grow tax-free—and qualified withdrawals are also tax-free. This can be particularly beneficial if you anticipate higher tax rates later in retirement.
4. No Required Minimum Distributions (RMDs)
Roth IRAs are not subject to RMDs during the account holder’s lifetime, giving you more control over your retirement income and tax exposure.
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Potential Drawbacks and Risks to Consider
1. Tax Bill at Conversion
Converting pre-tax funds to a Roth IRA creates taxable income in the year of conversion. If not timed properly, this could push you into a higher tax bracket or increase your Medicare premiums.
2. Market Volatility Risk
If the market is up when you convert, you’ll owe tax on the higher account value. Timing conversions during market dips can be tricky but more favorable from a tax standpoint.
3. Legislative Risk
Tax laws can change. While Roth IRAs currently offer tax-free growth, there’s no guarantee future legislation won’t alter the rules around taxation or RMDs.
4. Missed Opportunity for Roth Growth Early On
By waiting until retirement to start Roth conversions, you may miss years (or decades) of tax-free growth that early Roth contributions could have provided.
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Key Factors to Evaluate
• Your current and projected future tax brackets
• Availability of cash to pay conversion taxes without dipping into retirement funds
• Your timeline to retirement and beyond
• Whether you plan to leave assets to heirs (Roth IRAs are more favorable for legacy planning)
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Should You Consider This Strategy?
This approach can be particularly effective for:
• Individuals expecting lower taxable income early in retirement (before Social Security and RMDs begin)
• Those with significant savings in pre-tax accounts and little in Roth accounts
• Households with flexibility to pay conversion taxes from outside their retirement portfolio
However, it’s not a one-size-fits-all solution. A well-timed conversion strategy requires careful coordination with your tax advisor and financial planner.
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Final Thoughts
Contributing to pre-tax retirement accounts and converting to a Roth IRA in retirement can be a smart way to manage lifetime taxes—but only if the details align with your unique financial situation.
At Full Circle Financial Planning, we help families, small business owners, and workers in the Jackson, Michigan area explore strategies like these as part of a comprehensive retirement plan. If you’d like to talk through how this may apply to your goals, let’s connect.
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