InvestmentNews columnist Ed Slott got a lot of people thinking about Roth IRA and Roth 401(k) strategies this week — and whether traditional tax-deferred saving should be anyone’s go-to in the current tax environment.
In his column Monday, Slott urged advisors to be “sounding the alarm” about growing pretax balances in 401(k) and individual retirement accounts and suggested they “have clients start making Roth IRA and Roth 401(k) contributions instead.”
However, advisors took some issue with the idea that tax deferral isn’t the way to go for every client.
Not everyone should stop contributing to traditional IRAs and 401(k)s, said Tim Steffen, director of advanced planning at Baird Private Wealth Management.
“I simply don’t agree with that,” Steffen said. “Not everyone is going to be in a higher [tax] rate than they are right now. If you’re somebody who is in your highest earning years right before retirement … it’s very possible that you’ll have lower rates in retirement.”
Income at the beginning of retirement is often low enough to put someone in a lower tax bracket than they were while working, although that changes during retirement, and people tend to go up in tax brackets, Steffen said. Rather than eschewing traditional 401(k)s and IRAs altogether, savers should consider what their average tax rates will be throughout retirement — and that figure, for many, will be lower than their marginal rates today, he said.
HEDGING STRATEGIES
Roth accounts “are a hedge against the uncertainty of what future higher tax rates can do to your standard of living in retirement,” Slott wrote. Although tax deductions are lost when using Roth strategies, that’s a good thing, he said, as “the tax deduction has no real long-term value.”
“Tax deductions aren’t worth as much when tax rates are low, as they are now. Smart tax planning means taking income when rates are low and taking tax deductions when rates are high,” according to Slott.
Many people have lower income during retirement than in their working years, but for most “lower taxes in retirement are a myth,” he wrote. “For those who build the largest IRAs, taxes down the road will generally be higher as a result of deferring withdrawals until they’re required. This triggers larger IRA tax bills when minimum distributions become required.”
While tax rates are currently low, they will likely be low again even if marginal rates rise beginning in 2026, Steffen said.
“Frankly, no one knows if that will happen. And we will not know for a couple of years,” he said. “Even if [a tax increase] does happen, it’s pretty unlikely that’s the last tax law change we will ever see … We might see a temporary spike in tax rates, but I suspect we will see them fall again in the future, and then go up in the future. That’s just how these things work.”
The spirit of Slott’s column is good, but clients have different circumstances that warrant a variety of approaches. Those might not be the same for a 25-year-old and a 60-year-old, for someone who needs their money sooner rather than later, or for a client who has a variety of income sources in retirement, Steffen noted.
POWER OF TAX DEFERRAL
“While I’m an avid fan of Rothification and fully support maximizing these tax-free accounts, I do think that tax-deferred accounts can play a role in retirement portfolios,” Joanne Burke, founder of Birch Street Financial Advisors, said in an email. “If a client has a very large tax-deferred balance and is not desiring to take the full tax hit now on Roth conversions but is self-funding a portion or all of their long-term care medical needs, using the tax-deferred accounts can be a good tax strategy. When using the funds to pay for deductible long-term care expenses, you are able to virtually offset a significant portion of the taxable IRA distribution with the medical expense deduction.”
Further, traditional IRAs can be efficient for charitable giving, as using those assets “saves significantly on taxes because neither the client nor the charity pays income tax on the distribution,” Burke said.
Although he doesn’t typically disagree with Slott, Wealthspire financial advisor Kevin Brady said that stopping contributions to traditional 401(k)s isn’t ideal for everyone.
“For those in a high-tax bracket now (32%, 35%, 37%), the tax savings of pretax contributions are meaningful. This is especially true for those in states that have their own material income tax, like New York, California and others. Even further emphasis if the plan is to move from those states in retirement,” Brady said in an email. “We cannot plan effectively based on what we think taxes could be in the future, but what we…
Read More: Roth IRA or 401(k) for all? Not so fast, advisors say.