There is a “ticking time bomb” coming for many Americans’ retirement nest eggs—but there’s still plenty of time to defuse it before it wreaks havoc on the country’s cumulative retirement savings.
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—and that bill is only likely to increase, says IRA expert Ed Slott.
Original reporting by Alicia Adamczyk
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—and that bill is only likely to increase, says IRA expert Ed Slott.
Original reporting by Alicia Adamczyk
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00:00Experts say there is a ticking time bomb coming for many Americans' retirement nest eggs.
00:04But there's still plenty of time to defuse it before it wreaks havoc on the country's
00:07retirement savings.
00:09The time bomb is in the form of the huge tax bill many savers will owe when they start
00:12taking distributions from widely used tax-deferred retirement accounts like 401ks and traditional
00:17IRAs.
00:18And according to IRA expert Ed Slott, that bill is only likely to increase.
00:22As it stands, those who invest in a 401k or traditional IRA don't pay taxes on the contributions.
00:28But that means that the bill will come due in retirement when they withdraw funds.
00:32Because of this, the amount displayed on account statements is far higher than what people
00:35will actually be able to spend on living expenses, says Slott.
00:39And many people don't understand just how much they could owe.
00:42Slott explained,
00:43None of these accounts have been taxed.
00:45That's the deal we made with the government.
00:47We get a tax deduction, but we'll pay for it later.
00:49The IRA is an IOU to the IRS.
00:53And thanks to a soaring stock market, sizable inheritances, and a growing emphasis on investing
00:58early, Americans have an astounding amount of wealth tied up in these accounts.
01:02In the first quarter of 2024, Americans had $7.8 trillion invested in 401ks and $14.3
01:08trillion in IRAs, according to the Investment Company Institute, meaning retirement savers
01:13owe trillions in taxes.
01:15While many people are focused on how they should be saving now, Slott says more need
01:19to start accounting for their tax bill in retirement.
01:21One way to defuse the bomb?
01:23A Roth IRA conversion.
01:25Investors will pay taxes now, but Slott says that's better than waiting with tax rates
01:28being on sale right now.
01:30Although the federal rate maxes out at 37%, many will pay rates as low as 10 or 12%.
01:35We're at the lowest historical rates many of us are likely to ever see, says Slott.
01:40You don't realize how good you have it now.
01:42These are the good old days.
01:45When you convert a traditional IRA to a Roth IRA, you pay the taxes at the time of conversion.
01:50Slott says that while no one likes to pay taxes up front, it's never made more sense
01:53to do so.
01:54In over 40 years, he's never had a client regret a Roth conversion.
01:58As long as you're paying the tax, it will grow for the rest of your life, income tax-free,
02:02he says.
02:04Potential tax law changes make today's rates look doubly good.
02:07While many people expect to fall into a lower tax bracket in retirement, that isn't always
02:10the case.
02:11Slott calls the belief you will be in a lower tax bracket the number one retirement myth.
02:16And depending on the outcome of this year's presidential election, people may see their
02:19tax burden increase if the individual tax cuts from Donald Trump and the Republicans'
02:232017 Tax Cuts and Jobs Act expires after 2025.
02:28Slott also points to the country's current debt level, which sits at more than $35 trillion,
02:33as another reason he believes tax rates will increase.
02:35He argues that the last thing many people want is their retirement savings subjected
02:39to the uncertainty of what tax rates could be in the future.
02:42Either Congress is going to keep kicking the can down the road, or they'll have to raise
02:46taxes, he says.
02:47And the people at the highest risk of getting hit with those taxes are the ones with the
02:50most money in these tax-deferred vehicles.
02:53Other planning options include charitable giving and purchasing life insurance.
02:56Whatever planning savers decide to do now, it's better than standing idly by and getting
03:00a surprise in retirement, he says.
03:02There's an opportunity now to get that money out, says Slott.
03:06After next year, rates are supposed to go up again, so you still have around two years
03:10at the rock-bottom tax rates.