Why $1M in Retirement Savings May Shrink After Taxes

Stephen Dissette, an advisor at Horter Investment Management, emphasizes that retirees often face a surprise when withdrawing from traditional 401(k)s or IRAs because those distributions are taxed as ordinary income. He identifies four major threats to retirement success:

• Taxes
• Stock market risk
• Longevity (outliving savings)
• Long-term care expenses

His advice is to think about tax diversification in addition to investment diversification. One way to do this is by supplementing a 401(k) with a Roth IRA, since contributions are made with after-tax dollars and withdrawals in retirement are tax-free. For high-income earners, Roth conversions can also be a strategy, though they require careful planning to avoid unexpected tax bills due to IRS rules.

The key takeaway is that retirees should plan ahead for taxes, not just market risk. By balancing traditional accounts with Roth options, you can reduce the tax burden in retirement and preserve more of your savings for long-term needs.

Looking at your retirement plan holistically is essential. Taxes, market risk, longevity, and healthcare costs can all erode the value of your savings, so it’s not enough to focus only on account balances. Consider how different accounts traditional 401(k)s, IRAs, Roth IRAs, taxable brokerage accounts work together to provide flexibility and tax efficiency in retirement.

A Roth IRA or Roth conversion can be a powerful tool to reduce future tax burdens, but whether it’s right for you depends on your income, current tax bracket, and long-term goals. Because Roth conversions can trigger immediate taxes and involve IRS rules like the pro rata rule, it’s wise to consult a financial planner before making a move.

Diversify not just your investments, but also your tax exposure. Balancing traditional accounts with Roth options can help ensure you keep more of your money in retirement and protect against unexpected tax hits.

For Roth IRAs, contribution limits are $7,500 annually if you’re under 50, with an additional $1,100 catch-up contribution if you’re 50 or older. But there are restrictions:

• If your income is too high, you may not be eligible to contribute directly.
• If you’re already retired, you can’t contribute because Roth IRAs require earned income.

That’s where Roth conversions come into play. Many people with seven-figure retirement accounts assume they truly have $1M, but in reality, a large portion sometimes $300,000 or more will eventually go to taxes if the funds are in traditional 401(k)s or IRAs. Converting some of those funds into a Roth IRA means paying taxes upfront, but it ensures that future growth and withdrawals are tax-free.

This strategy is powerful because it diversifies not just your investments, but also your tax exposure. By balancing traditional accounts with Roth options, you reduce the risk of a heavy tax burden later in life and preserve more of your retirement savings for actual spending.

Stephen Dissette highlights that the biggest advantage of a Roth account is the ability to take withdrawals without paying taxes in retirement. The conversion itself is a taxable event, but it can be strategically managed.

Key points from his perspective:

• Tax Rates Are Historically Low: Converting now may mean paying less tax than you would in the future if rates rise.
• Flexibility in Timing: You don’t have to convert your entire account at once. Conversions can be spread out over several years to stay within your tax bracket.
• Tax Withholding Options: Just like a paycheck, you can withhold taxes during the conversion process. This prevents the need to dip into savings later to cover the tax bill.
• Strategic Planning: The amount converted is added to your taxable income, so careful planning ensures you don’t push yourself into a higher tax bracket unnecessarily.

The takeaway is that Roth conversions are not an “all or nothing” decision. They can be tailored to your income level and tax situation, making them a flexible tool for reducing future tax burdens and preserving more of your retirement savings.

A $1M retirement account doesn’t automatically mean you’ll have $1M to spend. Taxes, market volatility, longevity, and healthcare costs can reduce that balance significantly sometimes leaving you with closer to $700K in usable funds.

To protect your savings:

• Plan for taxes early by considering Roth IRAs or Roth conversions.
• Diversify both investments and tax exposure to avoid relying solely on traditional accounts.
• Account for longevity and healthcare costs so your money stretches further.

The most important point is that retirement planning isn’t just about building a large balance it’s about making sure you keep as much of it as possible when you need it.