Some people get really excited about Roth accounts, Roth conversions, and writing smaller checks to the IRS. They get so excited that sometimes they take it too far. They start using dangerous words like “always” and “never.” Or sometimes they carry out their ideas to their logical end, and that end is far from logical. Here are some examples of this sort of extremism:
- Convert all of your traditional accounts to Roth accounts.
- Always contribute to the Roth subaccount of your 401(k).
- A whole life insurance policy is a “Super Roth” and, thus, way better than a traditional 401(k) contribution.
- Take your money out of your retirement accounts as soon as you can.
- Required Minimum Distributions are bad things.
- Try not to let your traditional IRA grow too large.
- I want to pay as little in tax as possible.
- We are at historical lows as far as tax rates, and they can only go up from here.
- Pay taxes on the seed, not the harvest.
Your Goal Is Not to Pay the Least Possible Amount in Tax
The first point I want to make is that you should always remember that the general goal should not be to pay the least amount possible in tax. The goal should be to have the most left over AFTER paying tax. It doesn't matter if you pay $30,000 in tax now or $300,000 in tax later. That fact is irrelevant to most long-term tax-related decisions. Most of the time, you should be looking at tax rates, not absolute amounts of tax paid, and you'll end up with the right answer to your tax questions.
5 Reasons You Want Money in a Tax-Deferred Account
What is a tax-deferred account? We're talking about those pre-tax, “traditional” retirement accounts such as a 401(k), 403(b), 457(b) (especially a governmental one), traditional IRA, or SEP-IRA. Now, most of these accounts offer two types of subaccounts—a tax-deferred subaccount and a tax-free (or Roth) subaccount. We're just talking about the tax-deferred subaccounts. Here are five reasons you want one.
#1 Withdrawals at a Lower Tax Rate
The main reason you want a tax-deferred account is that an arbitrage is often available between your marginal tax rate at the time of contribution and your marginal tax rate at the time of withdrawal. If you can delay paying taxes at 35% and then pay those taxes later at 0% (amount equal to your deductions), 10%, 12%, 22%, or 24%, you're coming out way ahead.
Most people are not supersavers. Most people simply don't save enough money to put themselves into a higher tax bracket in retirement than the one they were in during their peak earnings years. Even if they are supersavers, they still want to have some money in tax-deferred accounts that can be withdrawn to fill the lower brackets (like 0%, 10%, 12%, etc.).
Imagine you had a $0 tax bill one year. That's a wasted opportunity. Your goal should be to pay taxes at the lowest possible rate for every dollar earned. Pre-paying taxes at a higher rate now in order to pay nothing in taxes later is a mistake.
In addition, most people will have a large chunk of their retirement money that won't be withdrawn/spent by them. It will be left to their heirs. And those heirs might also be in a lower tax bracket than they were during their peak earnings years. This is particularly relevant for high earners like white coat investors, whose children often earn much less.
Many people are also 100% convinced that general tax rates must go up. Just because general tax rates go up doesn't mean your marginal rate will, and there are often unexpected tax rate surprises. Prior to the Tax Cuts and Jobs Act (2018), plenty of people thought tax rates could only go up. Then, they went down. Plenty of people said tax rates were going to go up starting in 2026, but then OBBBA passed and maintained the current tax rates. Tax rates ARE NOT at historic lows. The historic low for the income tax rate was 0%. Even ignoring that fact, there have been four times in history when the maximum federal income tax rate was lower than it is now. Tax rates don't HAVE TO go up. Pessimism always sounds smarter, but history should be titled, “The Triumph of the Optimists.”
#2 Retain Optionality
One of the most beautiful things about having multiple types of retirement accounts is that you gain an immense amount of flexibility. Once you make a Roth contribution or do a Roth conversion, you've lost that flexibility. You've lost all kinds of options, the main one being the ability to do Roth conversions later. If tax rates fall or even if you just happen to have a lower income for a year or two, you can't go back and undo a Roth contribution or a previously done Roth conversion. If you decide you're not going to spend the money yourself and you're going to leave it to an heir in a lower bracket or to a charity, you no longer have that opportunity to save taxes. Tax-deferred accounts retain optionality that Roths (and taxable accounts) do not have.
More information here:
Tax-Deferred Retirement Accounts: A Gift from the Government
Wife vs. Husband: A Retirement Account Showdown
#3 Charitable Giving
Newsflash! Charities don't pay taxes. Paying taxes on money that goes to charity is often a mistake. There are so many ways to support charities with pre-tax dollars that it seems silly to miss out on that opportunity. Whether you view that as you saving money or the charity getting more, it's really the same thing. Since OBBBA passed, you can even give $1,000-$2,000 to charity each year without itemizing on your taxes.
But the very best way to give to charities is to use your tax-deferred accounts. It is such a great deal that the IRS doesn't let you do it until you get into your 70s. These gifts are called Qualified Charitable Distributions (QCDs) and are limited to $111,000 [2026, but indexed to inflation for future years] per year. However, when you die, you can leave your entire tax-deferred account to charity. If you do so, NOBODY ever paid income taxes on that money. You didn't pay taxes when you earned it. You didn't pay taxes as it grew. You didn't pay taxes when you took it out of the account. The charity didn't pay any taxes on it. There aren't many ways you can totally eliminate the IRS from the process, but this is one of them. But if you don't have any tax-deferred accounts, this is not an option for you.
Now, you can still get a charitable deduction as part of your itemized deductions on Schedule A. But since OBBBA, significant limitations have been placed on that method (the first 0.5% of AGI isn't deductible, maximally deductible at 35% instead of 37%) of getting a tax break for donating to charity. It's just better to use the tax-deferred account and never have that income show up on your tax return in the first place.
#4 Medical Expenses
Medical expenses above 7.5% of Adjusted Gross Income (AGI) are deductible, but not if you don't have any taxable income to deduct them against. For many retirees, their only (or at least main) source of taxable income is withdrawals from tax-deferred accounts. If everything you have is in a Roth IRA, you'll miss out on having the ability to spend pre-tax money on medical (and long-term) care. Elderly people often have very high medical and long-term care expenses since room and board at a nursing home count. Yes, a Health Savings Account (HSA) is a little better than a traditional IRA, but once that is gone, the traditional IRA may be the next best thing.
#5 Sometimes the Only Option
More and more often, employers and the IRS offer a Roth option on an account. Employer matches and catch-up contributions can even be Roth now. But sometimes Roth contributions aren't possible. However, even in those situations, it's better to invest inside the tax-protected and asset-protected retirement account than outside of it.
Tax-protected growth is valuable, especially over long periods of time. Not having to pay taxes on dividends eliminates tax drag. More significantly, you can avoid capital gains taxes when you change from one investment to another. Plus, in the (admittedly unlikely) event that you have to declare bankruptcy due to an above policy limits judgment not reduced on appeal, you get to keep your retirement accounts (including IRAs in most states). So, your question isn't “tax-deferred or Roth;” it becomes “tax-protected or taxable,” and that's usually a no-brainer.
More information here:
Early Retirees Should Max Out Retirement Accounts
How to Use Tax Diversification to Reduce Taxes Now AND in Retirement
The Bottom Line
Roth accounts can be pretty awesome, but don't get carried away. Building and maintaining a tax-deferred account has its advantages.
What do you think? Why do people get so carried away with their tax fears? What mistakes do you see people making due to this fear?