Imagine working hard your entire life, saving diligently in an IRA or your company’s 401(k) plan, and now it’s time to retire and enjoy the golden years. With a well-earned nest egg, you're finally ready to travel and relax.

What if the true cost of your retirement?

Now imagine that, in your first year of retirement, you are going on a trip to Europe, and you have budgeted $10,000 from your IRA for this adventure—but wait! When you get home from the trip, you discover that your adventure had actually cost you $12,000 due to the taxes on your withdrawal!

Worse yet, imagine purchasing your dream 35’ luxury Class A motorhome for $100,000 to travel the country in, but then after driving it across the nation, at the end of the year, you find out that it actually cost $125,000! What devious phenomena could be driving this cost increase? Well, depending on your perspective, it may not be all that devious, but it is an enduring part of life, and that is taxes!

Unlike with a Roth IRA, traditional IRA withdrawals can trigger taxable events.

Many people approaching retirement make the mistake of thinking they have paid their dues to Uncle Sam while working, and now they don’t have to worry so much about that, but in all actuality, this could not be further from the truth!

While Social Security is not generally taxable income by itself, it does not take much of a traditional IRA withdrawal to trigger taxable events on your Social Security income. In addition, the IRS has been waiting very patiently your whole career for your pre-tax contributions into your traditional IRA, 401k, or other qualified plan to grow tax-deferred, so that they can finally tax the higher amount when you need it for retirement living.

With a traditional IRA, the IRS requires you to make withdrawals (and be taxed)!

Furthermore, the IRS will force you to pull that money out at age 72 (up from 70 ½ thanks to the SECURE Act of 2019), whether you like it or not, in the form of a required minimum distribution (RMD) every year. The 2024 regulations continue to enforce this, and the RMD can be especially aggravating for frugal spenders who have saved up large IRA nest eggs (they did that by being frugal!) and do not need to withdraw the money to live on, but are now forced to take the money out and get taxed on it. Not to mention the social security it drags in to be taxed also (as high as 85% of your social security is subject to tax)!

The IRS will not release its grip on your IRA until either it is gone, or until any remaining amount that passed to your beneficiaries has been taxed, sometimes at a very high rate due to a lump-sum distribution.

The traditional IRA is not a bad thing,
as it obviously has great tax benefits
during our working careers.

This is not to say that the traditional IRA is a bad thing, as it obviously has great tax benefits during our working careers. We all need income in retirement, and for people that are projected to be in relatively low tax brackets in their retirement years, it can be wise to stay with a traditional IRA for this purpose.

When might a Roth IRA be the best solution?

But what about those who don’t need to take out RMD-sized amounts of their IRA’s to live on, or who want to take larger sums of money out for a special purpose (e.g., a child’s wedding, travel, a big-ticket purchase or an unanticipated medical expenses like long-term care)? In this case, a Roth IRA might be the best solution.

The beauty of the Roth is it grows tax free,
and more importantly,
the money is distributed tax free.

5 Tax-related benefits of the Roth IRA

The Roth IRA is funded with after-tax dollars, but the beauty of the Roth is it grows tax free, and more importantly, the money is distributed tax free. The Roth IRA does not subject your Social Security payments to taxation, and the Roth IRA is also not subjected to RMDs, so you take the money out when you want to, not when Uncle Sam dictates. For legacy planning, the Roth IRA is distributed to your beneficiaries tax-free as well.

2 Scenarios where the Roth IRA shines: High retirement savings or large withdrawals in a single year

Scenarios when a Roth is advantageous include people with high amounts of retirement savings or those withdrawing large sums in a single year above what is normally needed to live on. A Roth can be especially useful as a savings fund to cover long-term care expenses. It sounds cruel to tax someone an extra 24-28% for nursing home expenses, but that is exactly what happens if you withdraw money from a traditional IRA to pay for it, and the IRS does not care!

Should you convert your traditional IRA to a Roth IRA?

Some people earn too much money to contribute to a Roth IRA, but they can often convert existing traditional IRAs, as well as old 401k plans or other qualified plans to a Roth. (Yes, you will pay taxes for this, but remember that someday you will pay taxes on it anyway!). It is important to remember that the 2017 Tax Cuts and Jobs Act lowered tax rates until 2026, which gives people two-year window to convert traditional IRA accounts to Roth accounts “on sale” (unless the Act is repealed for political reasons, in which case that window of time could be smaller).

With the country having a large deficit spending problem, it is likely that taxes will go up in the future. No one likes to pay taxes, but the question that must be asked is this: Do you do it now—knowing what you will pay—or do you face the uncertainty of potentially higher taxes in the future?

Do you pay taxes now—knowing what you will pay—or do you face the uncertainty of potentially higher taxes in the future?

F5 Financial can support you:

These are complex questions to answer, and every person is in a different situation. To learn more about the Roth IRA and whether channeling more of your retirement assets into this unique retirement solution makes sense for you, feel free to contact us at F5 Financial to request a free consultation.

Would You Like More Support?

• Do you have a well-defined Investment Policy Strategy that is used to drive your investments in support of a comprehensive financial plan?

• If not, would you like to partner with someone who is used to helping people get through these struggles and (then, with confidence) implement portfolio strategies in a systematic manner while focusing on your desired outcomes?

If so, feel free to send us an email or give us a call. We’d love to have the opportunity to help you find a bit more peace of mind when it comes to investing.

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