Did you think the Roth vs. Traditional debate ended when you created your roadmap to retirement? In reality, how you use these accounts now, in retirement, could be the difference between smooth sailing or unexpected taxes that creep into your Social Security, Medicare, and legacy plans.
The good news? You don’t have to become a tax expert. We’re breaking it down simply so you can see the real impact of Roth vs Traditional retirement accounts in retirement.
Why It’s Not Just About Taxes Anymore
When saving for retirement, the focus was mainly on getting money into your accounts. Now, it’s all about how you take that money out. As you pull money out of retirement savings vehicles, you still need to consider your taxable income, even if you’re not working. Your taxable income can affect how much of your Social Security is taxed, the cost of Medicare premiums, and whether you cross other income thresholds that trigger hidden costs.
But before we get too far into the conversation, let’s break down the fundamental difference between withdrawals from a Roth vs Traditional account in retirement:
Withdrawals From a Roth Retirement Account: These are generally tax-free, meaning they don’t count toward your taxable income as long as the account has been open for at least five years and you meet the age requirement (typically 59½). Roth withdrawals give you a powerful way to access cash without increasing your tax burden.
Withdrawals from a Traditional Retirement Account: These are treated as ordinary taxable income. Each dollar you withdraw adds to your taxable income for the year, which can push you into a higher tax bracket.
How Your Retirement Phase Changes the Game
During your working years, it was all about accumulation. Now you’re in the distribution phase — and the priorities shift.
One big factor is Required Minimum Distributions (RMDs). Once you reach 73 or 75 (if born 1960 or later), the IRS requires you to start pulling money out of your Traditional accounts whether you need it or not. RMDs are considered taxable income. This makes sense because you’ve never paid income tax on the dollars deposited into the account, meaning the IRS is capping the time you can sit on the funds before paying taxes. Here’s an overview from the IRS regarding what accounts are subject to RMDs:
The RMD rules apply to all employer-sponsored retirement plans, including profit-sharing plans, 401(k) plans, 403(b) plans, and 457(b) plans. The RMD rules also apply to traditional IRAs and IRA-based plans such as SEPs, SARSEPs, and SIMPLE IRAs.
The RMD rules do not apply to Roth IRAs or Designated Roth accounts while the owner is alive. However, RMD rules do apply to the beneficiaries of Roth IRA and Designated Roth accounts.
Roth IRAs, on the other hand, are a different story. They don’t have RMDs during your lifetime, meaning you have more control over how much you withdraw and when.
Real-World Examples: How It Plays Out
Let’s look at a few practical examples of how retirees may approach the decision of when to use Roth vs Traditional funds in retirement:
- Bill and Susan stay under a key Medicare threshold by pulling from Roth accounts when they unexpectedly find themselves in need of a new vehicle and want to pay cash. By using their Roth IRA instead of Traditional funds, they kept their taxable income low enough to avoid a sharp increase in Medicare premiums.
- Mike reduces taxes in a big year of home repairs after storm damage causing him to dip into savings. By pulling a portion from his Traditional IRA and a portion from his Roth, he balanced his tax hit and avoided pushing himself into a higher bracket.
- Patty leaves tax-free Roth money to her heirs since she doesn’t need the money to reach her monthly income requirements. Her heirs will receive the money tax-free. This is a simple yet powerful way to give while reducing the workload for your heirs.
Each of these situations is different, but they all had something in common: planning ahead gave them choices.
Common Misconceptions That Could Cost You
It’s easy to fall into a few traps when it comes to managing Roth and Traditional accounts in retirement:
- “I’ll be in a lower tax bracket later.” Maybe, but not always. Future tax laws can change, and many retirees find that RMDs, Social Security, and other income sources add up fast.
- “I should empty my Traditional account first.” Not necessarily. A blended approach may be preferred if the goal is to smooth taxes over time. But we can’t provide specific advice without reviewing your unique scenario and goals.
- “I don’t need to think about this yet.” Timing matters. A little planning can pay off in the long run. Your future self will thank you.
Small Shifts, Big Impact
You don’t have to get everything perfect. But being intentional about your Roth and Traditional strategies can make a real difference in your retirement experience.
Small shifts now, like planning your withdrawals thoughtfully, can reduce surprises. We encourage you to remain informed as each little decision you make regarding your financial future matters.
If you’d like planning support, we’re here to help. Book a call to learn more about our comprehensive retirement planning services.
About Foundation Wealth Management
Foundation Wealth Management is a CPA-led organization, that provides financial planning services and tax planning support; services and outcomes vary based on each client’s circumstances. Our team includes qualified professionals, such as CPAs and CFP®s, who are integral to our service offerings. Our team includes 3 Certified Financial Planners: Burt Hutchinson, CPA, CFP®, Paul LaViola, CFP®, and Stephen McDade, CFP®.
As Fee-Only planners, we are compensated directly by clients rather than through commissions from brokerage or insurance products, which we believe helps align our services with client goals.
Sources:
- https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs#:~:text=What%20are%20required%20minimum%20distributions,year%20they%20reach%20age%2073.
- https://www.ssa.gov/benefits/medicare/medicare-premiums.html
Disclosure Statement:
This presentation is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third-party sources and is believed to be reliable; however, its accuracy is not guaranteed and should not be relied upon in any way whatsoever. This presentation may not be construed as investment, tax, or legal advice and does not give investment recommendations. Any opinion included in this report constitutes our judgment as of the date of this report and is subject to change without notice. All investments are subject to risk, including the possible loss of principal.
The client scenarios presented in this blog are entirely fictional and created solely for illustrative purposes. Any similarities to actual persons, entities, or events are purely coincidental and unintentional.
Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website, Past performance is not a guarantee of future results.
