One of the biggest reasons I was<\/em> against contributing to a Roth IRA<\/a> is my belief that most people won\u2019t make more money in retirement than while working. As a result, they\u2019re unlikely to pay a higher tax rate in retirement than during their working years.<\/p>\n This belief also assumes that tax rates will stay stable. Since 2009, when I first shared my views on\u00a0Financial Samurai, tax rates have generally trended lower. Just as cutting Social Security benefits is political self-harm, campaigning to raise taxes isn\u2019t a winning strategy for politicians seeking power.<\/p>\n Earning more money in retirement than during your working years requires effort, discipline, consistency, and a bit of good luck<\/a>. Considering the current state of personal finances in America\u2014which isn’t great\u2014this scenario is unlikely for most people.<\/p>\n Intuitively, many people understand this. However, let\u2019s dive into the numbers to get a clearer picture. I\u2019ll also explore why some of us might very well end up making more in retirement than we did while working. One key is understanding the concept of deferred income and how it is taxed.<\/p>\n <\/p>\n If we look at the median and average net worth for retirees, it\u2019s logical to conclude that most Americans will earn more while working than when retired.<\/p>\n Now, consider the\u00a0median net worth<\/a>\u00a0of $192,000 (based on the latest Consumer Finance Survey). Using the\u00a04% rule<\/a>, a safe withdrawal rate, this net worth generates only\u00a0$7,680 annually.<\/p>\n Fortunately, Social Security provides an average payout of\u00a0$22,333 per year<\/a>, and rises with an inflation index each year. Adding these together gives retirees a total income of\u00a0$30,013 annually.<\/p>\n Compare this to the median individual income of $43,000. $30,013 is about 30% less. The median net worth would need to be at least $325,000 higher, or over $517,000, for the typical retiree to make more in retirement.<\/p>\n On the bright side, retirees earning $30,013 annually don\u2019t need to worry much about taxes due to the standard deduction and lower marginal tax rates at this income level. I estimate that individuals can amass up to a $1.5 million<\/a> portfolio and still not have to pay much if any taxes in retirement. <\/p>\n While most Americans earn less in retirement, you aren\u2019t most people<\/em>. You subscribe to the free Financial Samurai newsletter<\/strong><\/a> and are obsessed about money and living an incredible life!<\/p>\n Readers of personal finance sites like this one are likely saving far more and investing more strategically than the average individual. We’re a nerdy bunch who care immensely about our financial future.<\/p>\n Thanks to the\u00a0power of compounding, decades of disciplined saving and investing could result in you earning far more in retirement than you ever anticipated.<\/p>\n Let\u2019s illustrate compounding\u2019s incredible potential. Suppose you invest $100,000 and earn an annual return of 10%. The example assumes\u00a0no additional contributions<\/strong>\u00a0after the initial $100,000 investment. Here\u2019s how your wealth grows over time:<\/p>\n It might take 30 years to reach your first million<\/a>, but by Year 50, compounding adds\u00a0millions annually\u00a0to your portfolio. Starting early and staying invested are key to building significant wealth.<\/p>\n Another reason you could earn more in retirement is the\u00a0tax treatment of withdrawals. This point didn\u2019t fully hit me until I spoke with\u00a0Bill Bengen, creator of the 4% Rule<\/a>, and after I wrote another post on minimizing taxes when withdrawing from retirement portfolios<\/a>.<\/p>\n Withdrawals from\u00a0401(k)s\u00a0and\u00a0traditional IRAs\u00a0are classified as\u00a0ordinary income, not capital gains. Why?<\/p>\n Once you think about 401(k) and IRA withdrawals as deferred income<\/a><\/strong>, it should now make sense as to why the withdrawals aren’t taxed as capital gains. Heck, think about your entire 401(k) and IRA balance as a big pot of tax deferred income the IRS is just waiting to get their hands on if you will. <\/p>\n All this time, you may have assumed that your investments in your 401(k) and IRA would eventually be taxed as capital gains\u2014at lower rates and not considered income. Unfortunately, you\u2019d be wrong.<\/p>\n Because of these rules, large\u00a0401(k)\u00a0or\u00a0IRA\u00a0balances can result in significant taxable income during retirement, especially when factoring in\u00a0Required Minimum Distributions (RMDs). Let’s now go through an example how how a retiree could make more in retirement. <\/p>\n Here\u2019s how the combination of RMDs, Social Security, and a large 401(k) could lead to higher retirement income:<\/p>\n RMD = $2,000,000 \u00f7 22.9 \u2248 $87,336<\/strong><\/p>\n In this scenario, the retiree earns\u00a0$2,336 more in retirement than while working. But in terms of taxable income, depending on where the person retires, the retiree earns $22,336 more in taxable income in retirement than while working. The $20,000 in annual untaxed 401(k) contribution while working one year simply shifted to taxable income in retirement.<\/p>\n Even if you make just a little bit more in retirement than while working, it feels much larger due to the following reasons:<\/p>\n Despite earning about 80% less in total income during my first year of retirement, I didn\u2019t feel much poorer. In my final two years of work, I had been saving over 70% of my income in anticipation of leaving the workforce. So my actual income available to spend only declined by about 10%.<\/p>\n The retirement transition brought immense happiness<\/a> as I gained full control over my time. I found joy in exploring free parks on weekdays, keeping myself entertained without spending much.<\/p>\n Writing for\u00a0Financial Samurai<\/em>\u00a0has also been far more fulfilling than working in banking. Without anyone dictating my tasks, I can freely explore my creativity and curiosity, writing about topics that truly interest me. While the income level is different, the joy of writing makes it worthwhile. When you\u2019re willing to write for free, any<\/em> online income<\/a> generated feels like a bonus.<\/p>\n Not accounting for 401(k) and IRA withdrawals as income was a blind spot in my earlier arguments for not wanting to contribute to a Roth IRA. Viewing these withdrawals as\u00a0deferred income<\/strong><\/em>\u00a0clarifies why they\u2019re taxed as such. For all you super 401(k) and IRA savers<\/a>, the pot of deferred income the government eventually forces you to tap will likely be substantial!<\/p>\n Another thing I underappreciated was the power of compounding. Conceptually, I understood it, but it took another 15 years of experience to truly believe in its impact. The investment gains since April 2020 have been nothing short of extraordinary.<\/p>\n Moreover, thanks to technology, more retirees are embracing side hustles<\/a> to generate additional income. The very definition of retirement has evolved\u2014from living a life of leisure to living a life of intentional purpose.<\/p>\n If you want to contribute to a Roth IRA<\/a>, go for it\u2014especially if your marginal income tax rate is 24% or lower. Diversifying your retirement income sources is always a smart move. <\/p>\n The only thing better than earning more in retirement than you did while working? Retiring early and making even more money not really working because you\u2019re doing what you love!<\/p>\n Readers, do you think you\u2019ll earn more in retirement than while working? Were you aware that withdrawals from 401(k)s and IRAs are taxed as ordinary income, or did you assume they\u2019d be taxed as capital gains since they\u2019re investments?<\/em><\/p>\n If you\u2019re serious about building wealth and retiring comfortably, consider signing up for Boldin\u2019s powerful retirement planning tools<\/a><\/strong>. They offer a free version and a PlannerPlus version for just $120\/year\u2014an affordable alternative to hiring a financial advisor. For the paid version, there’s a free 14-days trial. <\/p>\n Boldin was specifically designed for retirement planning, providing a holistic approach to financial management. It goes beyond managing your stock and bond portfolio by integrating real estate investments, guiding Roth conversions to minimize taxes, helping with college savings, and addressing other real-life financial scenarios we all face.<\/p>\n As I approach the traditional retirement age<\/a>, I\u2019ve found Boldin\u2019s tools particularly helpful in deciding how much to convert to a Roth IRA. The ability to model various \u201cwhat if\u201d scenarios has been invaluable for planning my future, especially for when I\u2019m older and less able to manage my finances.<\/p>\nWhy Most People Will Earn Less in Retirement<\/h2>\n
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WhyYou<\/em>\u00a0Might Earn More in Retirement Than While Working<\/h2>\n
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The Power of Compounding<\/h3>\n
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Why Withdrawals Are Considered Income<\/h3>\n
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Example Of A Retiree Earning More in Retirement<\/h2>\n
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Retirement Years<\/strong>:<\/h4>\n
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Why Retirement Income Also Feels Much Larger<\/h2>\n
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It’s Been A Good Semi-Retirement So Far<\/h3>\n
Maybe We’ll Earn More In Retirement After All<\/h2>\n
Reach Financial Freedom Sooner With Boldin<\/strong><\/h2>\n
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