When I ask pre-retirees with large 401(k)s how they plan to handle the taxes on those accounts, I usually hear some version of the same answer: “We’ll wait until we retire. Our income will drop, and we’ll be in a lower bracket.”
However, “What will my tax rate be the year after I stop working?” is the wrong focus for a household with $2 million or more in pre-tax savings.
It’s far more useful to consider what you and your spouse, and eventually your children, may pay in taxes across all the years that money will be withdrawn.
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Your deduction today is a decision about decades
Deferring taxes while you work can make sense, and today’s deduction is a real benefit.
But a traditional 401(k) or IRA isn’t entirely yours to spend. Every dollar that comes out is generally taxed as ordinary income, and the balance that will eventually be taxed keeps growing along with your investments.
At a hypothetical 6% annual return, $2 million doubles to roughly $4 million in about 12 years. That growth is good news, but it also means the pool of income you’ll eventually pay tax on may be much larger than the one you’re looking at today.
You also won’t have full control over when that income shows up. Required minimum distributions (RMDs) generally begin at 73, or 75 if you were born in 1960 or later, and they’re calculated from your pre-tax balance whether you need the money or not.
Where ‘lower later’ tends to break down
Retirement can open a window of lower-income years. But for large pre-tax savers, that window is often shorter than expected.
Income stacks. RMDs add taxable income. Higher income can make up to 85% of your Social Security benefits taxable. It can also trigger Medicare IRMAA surcharges on Part B and Part D premiums, which are based on your tax return from two years earlier.
Market declines leave fewer choices. A downturn strains any retirement portfolio. But if all of your savings are pre-tax, every withdrawal you take to cover spending also adds taxable income. Roth savings don’t protect you from market losses, but they give you another account to draw from without raising your tax bill.
A surviving spouse files alone. After one spouse dies, the survivor generally files as a single taxpayer. Household income often doesn’t fall by much, especially if the survivor inherits the IRAs, but the tax brackets are roughly half as wide.
Your children inherit the tax bill, too. Most non-spouse beneficiaries must empty an inherited IRA within 10 years, according to IRS Publication 590-B. Those withdrawals are generally taxable, and for many adult children they land during their own peak earning years. Inherited Roth IRAs have distribution rules too, but qualified withdrawals can be tax-free.
None of these factors makes a Roth conversion the right move on its own. But together, they’re the reason “we’ll be in a lower bracket” isn’t the same as “we’ll pay less.”
What paying tax now can buy, and what it costs
A Roth conversion doesn’t avoid tax. You recognize income today and move that amount into a Roth account, where future growth may be withdrawn tax-free if you meet the IRS qualified-distribution rules.
In return, you get more control. A smaller pre-tax balance can mean smaller RMDs later. Qualified Roth withdrawals aren’t counted in gross income, so they generally don’t increase the taxable portion of Social Security or the income Medicare uses to set IRMAA. And as the original owner of a Roth IRA, you aren’t required to take distributions from it during your lifetime.
The costs are just as real. A conversion raises this year’s tax bill and can push you into a higher bracket or trigger higher Medicare premiums two years later. Paying the tax from savings outside your IRA uses money you could otherwise keep invested. A conversion can’t be undone. And if your future tax rate really is lower, waiting may cost less.
So the real decision is when to recognize income, and whether paying some tax now may lower what your household pays over both spouses’ lifetimes.
How to test the assumption
If you’re within 10 years of retirement or recently retired, these steps can show whether waiting is really your cheapest path.
1. Sort your savings by tax treatment. List pre-tax 401(k)s and IRAs separately from Roth and taxable accounts. Many couples I work with are surprised by how much of their net worth carries a future tax bill.
2. Project income, not just a rate. Estimate what RMDs may look like alongside Social Security, pensions and planned withdrawals. The question is how much income will land on your return each year, and in which years.
3. Plan for both spouses, and your heirs. Run the numbers for the years after one spouse is gone and for what your children would receive. Those are the years a pre-tax-heavy plan is most likely to cost more.
4. Convert in pieces. A conversion plan doesn’t mean moving an entire account in one year. Many households convert enough to use available room in a chosen bracket, then pause in years with a bonus, a business sale or a large capital gain.
5. Line up the tax payment first. Decide how you’ll pay the tax, and adjust withholding or estimated payments before you convert. Your tax professional can help you check the effect on Medicare premiums and state taxes.
Make waiting a choice
Waiting until retirement to convert may still be the right answer for you. But it should be a conclusion you reach after comparing your options over both spouses’ lifetimes, not a default you accept because it’s what most people do.
Every pre-tax dollar will be taxed at some point. You have the most say over when that happens in the years before RMDs and other retirement income begin to stack up.
Projections depend on assumptions about returns, tax law and your circumstances, and they cannot guarantee a lower tax bill. The 6% return above is hypothetical and does not represent any specific investment.