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There is a \u201cticking time bomb\u201d coming for many Americans\u2019 retirement nest eggs\u2014but there\u2019s still plenty of time to defuse it before it wreaks havoc on the country\u2019s cumulative retirement savings. <\/p>\n
The time bomb is in the form of the huge tax bill many savers will owe when they start taking distributions from widely-used tax-deferred retirement accounts like 401(k)s and traditional IRAs\u2014and that bill is only likely to increase, says IRA expert Ed Slott, who recently released the book The Retirement Savings Time Bomb Ticks Louder<\/a><\/em>.<\/p>\n As it stands, those who invest in a 401(k) or traditional IRA don\u2019t pay taxes on the contributions, with the understanding that the bill will come due in retirement when they withdraw funds. But that means that the amount displayed on account statements is far higher than what savers will actually be able to spend on living expenses, says Slott. And many people don\u2019t understand just how much they could owe. <\/p>\n \u201cNone of these accounts have been taxed, that\u2019s the deal we made with the government. We get a tax deduction, but we\u2019ll pay for it later,\u201d Slott, who worked as a certified public accountant for 40 years, tells Fortune<\/em>. \u201cThe IRA is an IOU to the IRS.\u201d<\/p>\n And thanks to a soaring stock market, sizable inheritances, and a growing emphasis on investing early<\/a>, Americans have an astounding amount of wealth tied up in these accounts. In the first quarter of 2024, Americans had $7.8\u00a0trillion invested in 401(k)s and\u00a0$14.3 trillion in IRAs<\/a>, according to the Investment Company Institute. Meaning retirement savers owe trillions in taxes.<\/p>\n While many people are focused on how much they should be saving now, Slott says more need to start accounting for their tax bill in retirement.<\/p>\n \u201cIf you don\u2019t fix this now, you\u2019re going to pay a lot later,\u201d says Slott. \u201cYou have to look at the big picture. Don\u2019t look at, \u2018what I can save now,\u2019 look at, \u2018what I can get and my family can get longer-term.’\u201d <\/p>\n One way to defuse the bomb? A Roth IRA conversion. Savers will pay taxes now, but that\u2019s better than waiting, says Slott. Especially because tax rates are \u201con sale right now,\u201d with the top federal rate maxing out at 37% (many people pay rates as low as 10 or 12%). It\u2019s the best deal many may ever get.<\/p>\n \u201cWe\u2019re at the lowest historical lowest rates many of us are likely to ever see,\u201d says Slott. \u201cYou don\u2019t realize how good you have it now. These are the good old days.\u201d<\/p>\n A Roth conversion involves transferring assets from a traditional IRA to a Roth IRA. Taxes<\/a> are paid at the time of conversion (ordinary income taxes on the fair market value of the assets that are converted, as part of the saver\u2019s tax bill the following April), and while no one likes to pay taxes upfront, says Slott, it\u2019s never made more sense to do so. In over 40 years, he\u2019s never had a client regret a Roth conversion, he says. And while the highest earners are restricted from contributing to a Roth outright, there is no income limit on Roth conversions.<\/p>\n \u201cAs long as you\u2019re paying the tax, it will grow for the rest of your life income-tax free,\u201d he says. \u201cAll that compounding is growing in your favor, you don\u2019t have to share it anymore with Uncle Sam. That\u2019s what you get for paying now at bargain basement rates.\u201d<\/p>\n Potential tax law changes make today\u2019s rates look doubly good. While many people expect to fall into a lower tax bracket in retirement, that isn\u2019t always the case\u2014Slott calls the belief you will be in a lower bracket the \u201cnumber one retirement myth\u201d). And given that the individual tax cuts implemented as part of the 2017 Tax Cuts and Jobs Act expire after 2025, many people may see their tax burden increase. (Depending on the outcome of this year\u2019s presidential election, they may not be renewed.)<\/p>\n Slott also points to the country\u2019s current debt level\u2014it sits at more than $35 trillion\u2014as another reason he believes tax rates will increase. He argues that the last thing many people want is their retirement savings subjected to the uncertainty of what tax rates could be in the future.<\/p>\n \u201cEither Congress is going to keep kicking the can down the road, or they\u2019ll have to raise taxes,\u201d he says. \u201cAnd the people at the highest risk of getting hit with those taxes are the ones with the most money in these tax-deferred vehicles.\u201d<\/p>\n Recent tax law changes also make traditional IRAs less appealing retirement savings vehicles, says Slott. Savers will start taking required minimums distributions (RMDs) at age 73, and the so-called stretch IRA was eliminated<\/a>.<\/p>\n \u201cWhen you do Roth conversions, you are controlling your tax rates. You can control each year what you\u2019re paying,\u201d he says. \u201cWith RMDs, you\u2019re not controlling anything. It\u2019s a forced distribution.\u201d<\/p>\n Other planning options include charitable giving and purchasing life insurance. Whatever planning savers are spurred to do now, it\u2019s better than standing idly by and getting a surprise in retirement, he says.<\/p>\n \u201cThere\u2019s an opportunity now to get that money out,\u201d says Slott. \u201cAfter next year, rates are supposed to go up again. So you still have [around] two years at the rock bottom tax rates.\u201d<\/p>\n<\/div>\nNow\u2019s the time for a Roth conversion<\/h2>\n
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