When you were a kid, and your mom asked you clean your room or pause your video game or come in for dinner, you likely told her some variation of, “in a minute” or “I’ll do it later.”
That same attitude would make you a very conventional accountant, says Ed Slott, a certified public accountant and founder of IRAHelp.com. “From day one training as an accountant, they tell you to never pay tax before you have to. Defer, defer, defer,” he says.
These days, Slott jokingly calls himself a reformed accountant, because he’s completely changed his approach to his clients’ tax burden. “I call it my key ‘always’ rule: Always pay taxes at the lowest rates,” he says. “Always keep more money.”
Because tax rates are currently so low relative to their history, “taxes are on sale now,” Slott says. People can take advantage of this moment, he added, by exploring moving their money from traditional accounts into tax-free vehicles, such as Roth IRAs. “That’s where everything should be headed.”
This may seem like it involves some complex planning, but Slott says the thinking behind it is simpler than you might think.
How Roth accounts work
With a traditional account, like a 401(k) or IRA, contributions you make in a given year can be subtracted from your taxable income.
In other words, you’re deferring paying tax on the portion of your income you’re stashing away. When you eventually withdraw that money in retirement (and after a certain age you must began taking withdrawals), you’ll owe income tax on it.
Roth accounts work the opposite way.
You fund a Roth IRA or Roth 401(k) with money you’ve already paid taxes on. Money in your account grows tax-free. Then, providing you’re age 59 ½ and have held the account for five years, you can take your contributions and earnings out in retirement without owing the government another dime.
If you have most of your retirement assets tied up in traditional accounts, you can move money over to a corresponding Roth account in a move known as a Roth conversion. Since you didn’t pay tax on the money upfront, however, you’ll owe a tax bill when you convert.
Why now is a good time to save in a Roth account
The question of whether to use a traditional or Roth account generally comes down to whether you prefer to pay taxes now or later.
Under one popular line of thinking, early-career workers should opt for the Roth since they tend to earn less money and owe less in taxes. Higher earners, meanwhile, should take the upfront tax break.
Slott believes that just about everyone could benefit from saving in a Roth account. That’s because regardless of personal tax rates, two key factors are likely to drive up the amount of tax you will owe in retirement:
1. The growth of the value of your portfolio. “The market has gone up like crazy. That’s not guaranteed, but historically, the market has moved up and down in a jagged way, but generally upward,” Slott says.
If you’re saving in a Roth account, all of the gains in your account can eventually be withdrawn tax-free.
For savers with traditional accounts, they are growing the tax burden they’ll owe in retirement, the more their portfolio returns.
“That tax is constantly building,” says Slott. “The values are up, but that means the eventual share that will be going to Uncle Sam will be higher, too. He’s a special beneficiary on your retirement account.”
2. Historically low tax rates. The other major reason to pay tax on Roth savings right now, rather than paying later, is that tax rates are historically low.
From from 1951 to 1963, for example, the top rate hovered above 90%, dropping to 77% in 1964. Today, the top marginal tax rate is 37%. Slott noted that it seems unlikely that the tax rates will go even lower across the board between now and the time you retire.
The tax rates fell to their current level with the passage of the 2017 Tax Cuts and Jobs Act — but that set of cuts that are set to expire in 2025. Even if the next administration maintains tax brackets at current levels next year, there’s still a growing federal debt that Congress will eventually have to deal with – possibly by hiking tax rates, Slott says.
That means, even if you currently fall into a high tax bracket, having at least some of your money in a Roth account acts as a hedge against rates climbing even higher.
For Slott, having a source of tax-free income in retirement provides the ultimate peace of mind. “I have everything placed in tax-free vehicles,” he says. “You don’t have to worry about the uncertainty of what higher tax rates could do to your standard of living in retirement.”
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