One of the biggest reasons I was against contributing to a Roth IRA is my belief that most people won’t make more money in retirement than while working. As a result, they’re unlikely to pay a higher tax rate in retirement than during their working years.
This belief also assumes that tax rates will stay stable. Since 2009, when I first shared my views on Financial Samurai, tax rates have generally trended lower. Just as cutting Social Security benefits is political self-harm, campaigning to raise taxes isn’t a winning strategy for politicians seeking power.
Earning more money in retirement than during your working years requires effort, discipline, consistency, and a bit of good luck. Considering the current state of personal finances in America—which isn't great—this scenario is unlikely for most people.
Intuitively, many people understand this. However, let’s dive into the numbers to get a clearer picture. I’ll 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.
Why Most People Will Earn Less in Retirement
If we look at the median and average net worth for retirees, it’s logical to conclude that most Americans will earn more while working than when retired.
- The median household income in the U.S. is about $80,000.
- The median individual income is about $43,000.
Now, consider the median net worth of $192,000 (based on the latest Consumer Finance Survey). Using the 4% rule, a safe withdrawal rate, this net worth generates only $7,680 annually.
Fortunately, Social Security provides an average payout of $22,333 per year, and rises with an inflation index each year. Adding these together gives retirees a total income of $30,013 annually.
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.
On the bright side, retirees earning $30,013 annually don’t 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 portfolio and still not have to pay much if any taxes in retirement.
WhyYou Might Earn More in Retirement Than While Working
While most Americans earn less in retirement, you aren’t most people. You subscribe to the free Financial Samurai newsletter and are obsessed about money and living an incredible life!
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.
Thanks to the power of compounding, decades of disciplined saving and investing could result in you earning far more in retirement than you ever anticipated.
The Power of Compounding
Let’s illustrate compounding’s incredible potential. Suppose you invest $100,000 and earn an annual return of 10%. The example assumes no additional contributions after the initial $100,000 investment. Here’s how your wealth grows over time:
- Year 1: $100,000 → $110,000
- Year 10: $100,000 → ~$259,000
- Year 20: $100,000 → ~$672,000
- Year 30: $100,000 → ~$1.74 million
- Year 40: $100,000 → ~$4.52 million
- Year 50: $100,000 → ~$11.74 million
It might take 30 years to reach your first million, but by Year 50, compounding adds millions annually to your portfolio. Starting early and staying invested are key to building significant wealth.
Why 401(k) And IRA Withdrawals Are Considered Income
Another reason you could earn more in retirement is the tax treatment of withdrawals. This point didn’t fully hit me until I spoke with Bill Bengen, creator of the 4% Rule, and after I wrote another post on minimizing taxes when withdrawing from retirement portfolios.
Withdrawals from 401(k)s and traditional IRAs are classified as ordinary income, not capital gains. Why?
- Contributions were pre-tax: You didn’t pay income tax on contributions, so taxes are deferred until withdrawal.
- Growth was tax-deferred: The IRS lets investments grow tax-free in these accounts, but it recaptures taxes later by treating withdrawals as income.
Once you think about 401(k) and IRA withdrawals as deferred income, 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.
All this time, you may have assumed that your investments in your 401(k) and IRA would eventually be taxed as capital gains—at lower rates and not considered income. Unfortunately, you’d be wrong.
Because of these rules, large 401(k) or IRA balances can result in significant taxable income during retirement, especially when factoring in Required Minimum Distributions (RMDs). Let's now go through an example how how a retiree could make more in retirement.
Example Of A Retiree Earning More in Retirement
Here’s how the combination of RMDs, Social Security, and a large 401(k) could lead to higher retirement income:
Working Years:
- Annual Salary: $120,000
- 401(k) Contributions: $20,000 (pre-tax average annual contribution)
- Take-Home Pay After Contributions: $100,000
Retirement Years:
- 401(k) Balance: $2 million (after 30 years of growth)
- Social Security: $35,000 annually
- RMDs: At age 75, the IRS distribution factor is 22.9.
RMD = $2,000,000 ÷ 22.9 ≈ $87,336
- Total Retirement Income:
- RMD: $87,336
- Social Security: $35,000
- Total: $122,336
In this scenario, the retiree earns $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.
Why Retirement Income Also Feels Much Larger
Even if you make just a little bit more in retirement than while working, it feels much larger due to the following reasons:
- No Need to Save for Retirement: The $20,000 saved annually during working years is now available for spending. Not saving for retirement once you are retired is one of the biggest “expense” savings working people do not fully account for. Treating investments as expenses is a smart mental trick to building more wealth over time.
- Lower Tax Rate: Social Security is taxed at a lower rate, and effective tax rates are often reduced for retirees. For example:
- A single filer with $122,336 income pays ~$8,060 in federal taxes after the standard deduction.
- A married filer with the same withdrawal income pays $0 to almost $0 in federal taxes due to higher 0% bracket thresholds and the standard deduction.
- Reduced Expenses: Commuting, work attire, and other work-related costs are eliminated in retirement.
- Earning Side Income Becomes More Enjoyable: For many retirees, part-time work becomes a fulfilling way to stay active. The difference is that you’re no longer working out of necessity but out of choice. This shift brings greater satisfaction as you enjoy being productive, helpful, and connected to your community.
- Earning Investment Income Feels Like Free Money: Earning passive investment income in retirement can feel almost like cheating—it requires no ongoing effort on your part. While it’s true that building up your investments initially demands significant work and discipline, over time, the power of compounding takes over.
It's Been A Good Semi-Retirement So Far
Despite earning about 80% less in total income during my first year of retirement, I didn’t 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%.
The retirement transition brought immense happiness as I gained full control over my time. I found joy in exploring free parks on weekdays, keeping myself entertained without spending much.
Writing for Financial Samurai has 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’re willing to write for free, any online income generated feels like a bonus.
Maybe We'll Earn More In Retirement After All
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 deferred income clarifies why they’re taxed as such. For all you super 401(k) and IRA savers, the pot of deferred income the government eventually forces you to tap will likely be substantial!
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.
Moreover, thanks to technology, more retirees are embracing side hustles to generate additional income. The very definition of retirement has evolved—from living a life of leisure to living a life of intentional purpose.
If you want to contribute to a Roth IRA, go for it—especially if your marginal income tax rate is 24% or lower. Diversifying your retirement income sources is always a smart move.
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’re doing what you love!
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Boldin is 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.
As I approach the traditional retirement age, I’ve found Boldin’s tools particularly helpful in deciding how much to convert to a Roth IRA. The ability to model various “what if” scenarios has been invaluable for planning my future, especially for when I’m older and less able to manage my finances.
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Taxes will most definitely be higher in the future:
https://budgetmodel.wharton.upenn.edu/issues/2023/10/6/when-does-federal-debt-reach-unsustainable-levels
I’ve read and heard of such same reports since 2009, and tax rates have stayed the same or gone down.
What power-hungry politician is willing to run on raising taxes if they want to retain power?
I will be retiring at 55 with a full pension that is not taxed state and city, just federal. My pension will be a little over 60% of my income, but I will bring home a lot more because of lack of taxes, SS and 401k deductions. I hope to not have to touch my retirement accounts until forced to by age, but I will be at the mercy of inflation, healthcare and greedy landlords (I will never have enough to own my home in my city). I doubt I will be able to do that, but I’ve tried to save as much as possible if my costs outpace my pension (which doesn’t go up). Most people reading this blog make much more than I do and have more to fall back on, but I’ve done my best.
Healthcare is the scary part. In retirement my medical and prescription costs go up immediately and the way my retirement is structured when medicare age happens it goes up even more. My city is trying to push people off of traditional medicare and retiree groups have fought and won, but the court cases keeps happening-the city has lost every case but does end runs to hurt retirees financially where they can. This is happening everywhere in America and the savings they claim are not true and sadly treatments are denied. Also, doctors are leaving the profession and it’s harder to get an appointment with certain doctors. My friend called for an appointment for a basic specialist in November 2024 and was told the first available was 2026. Also copays are going up and up and up. While fighting for approval of a scan I needed the place canceled it since it was first denied. I had to get a later appointment with the promise to pay for if it the insurance denied it. It was approved last minute, but I needed it so I would have paid for it. I still had to pay $100 for it. The year before it was $50. Before that it was $30 and ten years ago it was $10. And, I haven’t even mentioned dental costs. Preventative care for medical and dental saves everyone money (personally and nationally) in the long run, but many in power are shortsighted or just cruel. I also know plenty of people who have much more money than I will have have and are retired and are flipping out about their medical costs. This touches all Americans.
I am from the generation that never believed that I would get SS so it’s not planned for. I really don’t like it when people call it entitlements because most of those people don’t think people are entitled to it. We paid in and it was a loan to the government to pay others and we should all get it when it’s our turn. There should be no means testing (I may not like it that a billionaire is getting it, but they paid in) and increasing the age is just cruel. Raising the income maximum income for paying in or restarting it at $500,000 would help a lot. A few more dollars from the wealthy helps other Americans and that is their patriotic duty, and moral duty as a human. Many jobs cannot be worked when older and why should these people suffer. Also, it’s really stupid to force people to work longer and older because it blocks younger people from getting these jobs.
The moment we retired we got a raise. Our best year at work (2020) amounted to about $381K of which about 1/3 was passive income from investments. In our first year in retirement we clocked $483K without taking a penny from investments. I wish we retired earlier.
Here in Australia things are reversed. No tax at all in retirement on earnings and distributions from the first AUD 1.9 million invested in retirement accounts and 10-15% on the remainder. Earnings in these accounts are taxed at 10-15% until you retire and contributions are taxed at 15-30%. So a bit more like the Roth IRA.
You guys in Australia have the best retirement system in the world. And you guys also have the highest net worth per capita in the world. Congrats!
I would agree that politicians, and the voters who elect them, are not inclined to cut Social Security or Medicare nor do they want to raise taxes. So government debt piles up. As does China’s accumulation of U.S. Treasuries. All of which puts us on a collision course. The fact that the reckoning hasn’t occurred likely means that it will be far worse once it does.
Ignoring problems is rarely a solution.
Agree. Eventually, the roosters come home. What are some things you are doing to protect yourself and what do you think the government will end up doing to solve the problem?
I’ve done my best to insulate myself from these consequences. I retired 18 months ago with a net worth of 30X my income. More importantly my net worth is 60X my expenses while living very comfortably. The main concerns for me are tax avoidance and legacy wealth. I don’t even consider SSI as part of my long term planning and if I’m fortunate to receive Medicare (at a reasonable cost after taking IRMAA into account) I’ll consider that a bonus as well.
I don’t hold out any hope that the government will solve it’s entitlement obligation and debt problems anytime soon. We have no one to blame but ourselves for that because at the end of the day we choose how we’re going to be governed and what our priorities are. And we either don’t see this as a problem or simply choose to ignore it. I will be very interested to see if Musk and Ramaswamy do anything meaningful in this area. It would be impossible to accomplish their spending reduction goals without taking this on. If they don’t they aren’t serious. If they do they, and more importantly the President, will be very unpopular.
The idea of raising the retirement age sounds reasonable until it meets the reality of 70+ year old’s continuing to be meaningfully employed in an AI enabled world. We could, and likely should, means test SSI benefits as we do Medicare. But then you’re penalizing savers. Either way I don’t see the government acting until they absolutely have to. And it’s impossible to predict what will happen until we arrive at that moment and see what our options are. Let me know if your crystal ball is any better than mine.
Be wary of assuming there will be more money because of reduced expenses.
We spend $2500 a month now on unsubsidized healthcare insurance. It is just the cost of not having a day job. What you can do is incorporated business in retirement and deduct that expense if you have income.
It’s hard to know how you will feel and how much you will spend in retirement when you’re still working at 41. But I promise you you will feel different from what you expect.
Here are some of my perspectives on retirement after not having a day job since 2012:
https://www.financialsamurai.com/the-surprising-benefits-of-early-retirement-i-never-anticipated/
https://www.financialsamurai.com/the-negatives-of-early-retirement-life-nobody-likes-to-talks-about/
https://www.financialsamurai.com/how-does-it-feel-to-be-financially-independent/
https://www.financialsamurai.com/overcoming-the-one-more-year-syndrome/
When do you plan to retire? When you do, I hope you will return to this thread after subscribing and share with us your thoughts.
Very helpful insights. I hadn’t really thought about this before because my parents didn’t have enough for RMDs. But unless something drastic happens to my finances, I will have to account for them in my own retirement. Even though I have a long ways to go until collecting Social Security, this is very helpful to know about far in advance. Thanks!
Sam,
As always, I enjoy reading your articles! As a military retiree, age 55 with two children 11 and 8, I can’t believe I get to be a full time dad. My wife, registered nurse, full time mom. Although I didn’t amass a fortune as the mainstream FIRE readers have, I have learned so much from the younger generation about FIRE and the mindset going forward. I’m hoping to pass FI to my children as most of your readers. At times I feel guilty about not working, I have paid taxes since I was 14. But I am amazed that I will make more money in the next 20 years, provided good health, than I did the last 40! It’s crazy to me, but again your articles and shared view points help me stay the course and at the same time give thanks and feel grateful. Thank you and your wife again for sharing Financial Samurai, Happy New Year!
Hi Sam,
This is such a helpful post! My husband and I just retired last August at the age of 40 in Los Angeles and I’m literally trying to figure out what our retirement tax situation will be in 2025 and how to minimize taxes.
There are so many nuances with tax laws and withdrawal strategies that I’m sure we are all bound to make less than optimal decisions.
We have about 5-6 years of investments in a taxable brokerage. I’m planning on doing about a $100k ROTH conversion ladder each year less any other ordinary income from rental income, dividends, interest, and a new small business (which I’m doing for fun). Luckily I found out ROTH conversions can occur on 12/31 but effective 1/1 in the year of conversion so I can figure out how much I really need to convert now (to be able to use 5 years from now once the taxable brokerage runs out) with all other income considered. ROTH conversions are treated as ordinary income in the year of conversion.
What I also didn’t understand initially is how capital gain taxes work. For some reason I thought if I can keep my ordinary income below the $96.7k (capital gain tax 2025 bracket for married filing jointly), I can get away with not paying federal capital gain tax…I was wrong because capital gains + ordinary income less deductions counts toward calculating the income used to determine whether the capital gain is taxed at 0% or 15%.
Anyway, long way of saying it’s not really easy to navigate these tax withdrawals strategies without a tax professional’s help and that’s on purpose. Despite all the time researching, I’m grateful to have this problem and it’s never too late to start planning!
I am excited to check out Boldin tools to see how this will help with withdrawal tax planning!
“What I also didn’t understand initially is how capital gain taxes work. For some reason I thought if I can keep my ordinary income below the $96.7k (capital gain tax 2025 bracket for married filing jointly), I can get away with not paying federal capital gain tax…I was wrong because capital gains + ordinary income less deductions counts toward calculating the income used to determine whether the capital gain is taxed at 0% or 15%.”
Bingo. I am SURE a huge percentage of the working population does not know how taxation works. After doing my taxes since 2003, I’m still often confused until I do them and actually have to face paying taxes.
There isn’t a lot of free lunch from the government. However, knowing the standard deduction and income thresholds for 0% tax is important.
* The latest standard deduction amounts: $15,000 for singles and $30,000 for married couples for 2025.
* The income threshold for the 0% tax bracket on qualified dividends and long-term capital gains: $48,350 for singles and $96,700 for married couples.
Boldin’s Retirement Conversion tool is extremely powerful as it helps you optimize how much to convert and save on potential taxes. It’s one of the most popular tools in its suite of retirement planning tools. Boldin also has a thriving Facebook community if you want to trade notes there.
It’s funny, but as I edge closer to traditional retirement age, I am naturally thinking a lot more about traditional retirement planning. Life comes quick!
I’d recommend consulting with a CPA to discuss these issues. It will be well worth it to avoid making costly financial mistakes. Also, it will have psychological benefits by reducing anxiety because you will be confident you are making the right financial decisions.
Great post! You are describing what is happening to us.
We are not quite there yet. But in a few years we will be. And, while it may seem improbable to some readers, your analysis is sound.
The unknowns are: 1. Will Social Security remain solvent? 2. Will tax rates stay low?
On the latter, we have gradually converted about 35% of our IRA’s to Roth IRA’s so that if rates go up we have some insurance if taxes rise.
Yes, Social Security will remain solvent. Worst case, retirees get 75% of what was promised. Or the age to be able to withdraw goes up 2-5 years. Tax will most likely stay low through 2028 with Trump in office.
After 2028, I still think tax rates will stay low b/c politicians want power and to stay in power.
Sam,
I’m hard pressed to assume that “This belief also assumes that tax rates will stay stable.” over the next 30+ years of our retirement when current tax rates are some of the lowest in history.
We assume we will make about the same in retirement as we did in active working years. We also assume that tax rates will increase, not if, but when. Therefore, we started some Roth conversions in 2024.
Ron
You are blessed if you will be making more in retirement than while working. If you are comfortable sharing more details, that would be great.
I’ve had this argument about tax rate changes since I started Financial Samurai in 2009, not believing they would go up after Obama. And they have not, and instead have gone down. With 4 more years of Trump, tax rates will likely remain stable or go down further. So that will be 20 years of stable to declining tax rates by 2029.
And I’ll still maintain my position that tax rates will stay stable after 2029. Politicians cannot gain power and will lose power if they hike taxes. Further, once people are accustomed to lower taxes, it’s difficult to reverse.
That said, doing some Roth Conversions, especially at a 24% tax rate or preferably lower is a good idea. Enjoy!
Yes, we started conversions up to the top of the 24% bracket, and live in California, so it makes sense to us to do some Roth conversions. Might try Boldin to determine an optimal amount to convert… that seems like a harder number to determine.
Boldin’s Roth Conversion tool to figure out your optimal conversion amount for tax minimization is great. So many excellent what if retirement scenarios you can plan for too.
You also articulated a common belief that interest rates would stay low pretty much indefinitely as a rationale to take the ARM option even as fixed 30 year mortgages were in the 3s. That turned…very quickly.
The last time we raised tax rates, we have a balanced budget within 5 years. And yes, it did cost Clinton and propelled Newt and his New Deal into Congress. But the Treasury market is sending some clear hints about the 14T in debt from the last two Administrations. At the very least we must get the deficit to be less than annual GDP growth.
I don’t think the pandemic and the enormous trillions of dollars of stimulus to keep the economy Afloat will be a reoccurring situation.
I’m really happy with my 2.125% 7/1 adjustable rate mortgage as I don’t wanna pay more interest than I have to. People should match the duration of the term with how long they plan to own the mortgage or hold the house. I plan to sell this house within the seven year fixed rate timeframe.
Trump doubled the deficit to 1T before Covid struck. And before higher interest rates bumped our annual servicing to a trillion. I view the DOGE thing as comedic theater, not a serious attempt to reduce the deficit. As you note, the voters want stuff, and they don’t want to pay for it, and politicians (esp Republicans) have obliged. Until they can’t anymore.
Selling a spare home could be a solution for you when that 2.125% expires. But for those of us with the one home, selling one means buying another. I’d be pretty unhappy if my interest payments when from 2400 to 6409/month. That would blow me out of the 30/30/3-5 club. That increase is 80% of my existing I+P payment. And the 10 acre ranch I put my mother into in Oregon would not be viable if the fixed 3.1% became 6.
Your ARM stance works for those who have the capital to pay off a mortgage if the rates no longer favor keeping the debt and investing. But it’s perilous otherwise. One thing I observed when I last priced 2021 is that if rates stayed constant, the ARM would still be charging a higher than 30 year rate when the 7 years ended.
Only a minority of people have ARMs, less than 7%.
I’m not sure if people realize, but there’s an interest rate cap on ARMs. Usually 2% per year max, with a lifetime cap of 5% higher than initial.
So for a 2.125%, the most it jumps after the fixed duration is over is to 4.125% for year 8, then 6.125% for year 9, then 7.125% for 10 onwards if it is not refinanced. This is worst case scenario. Not great, but not terrible as principal gets paid down during this time. And the average ownership duration is about 12-13 years.
Related posts:
https://www.financialsamurai.com/how-much-can-an-adjustable-rate-mortgage-arm-go-up-after-the-fixed-period-is-over/
https://www.financialsamurai.com/30-year-fixed-mortgage-loan-vs-adjustable-rate-mortgage-arm-the-choice-is-obvious/
But if the Feds decide to solve this via a VAT tax, rather than a change to income taxes, this move falters.
I’m not part of the crowd that thinks they will reneg on the no taxes rule for Roth, but there are some crafty and well connected rich folks who would prefer to see the increase come from consumption which is more even than income which is not.