How to Pay Less on Retirement Account Withdrawals

There are two types of retirement accounts, Traditional and Roth accounts. Traditional accounts are what people are typically most familiar with, and they are used to defer income taxes until later years. Roth accounts allow the taxpayer to pay income taxes in the current year, grow the money tax-free, and withdraw the money tax-free. These are both powerful tools individually but are best used together.

To reduce lifetime income taxes on retirement account withdrawals, it is important to recognize taxes on retirement account balances in the tax years when we expect to be in the lowest income tax brackets, which is all based on our income. Essentially, in your higher income earning years, you should use a Traditional retirement account to defer the taxes, then recognize those taxes in the years where your income is lower (think job transition year, layoffs, going back to school, or retirement). 

Money can even be “converted” from the Traditional account to the Roth account in these years of reduced income, allowing the funds to grow tax-free following the conversion until the individual ultimately withdraws the funds tax-free in retirement.