This Retirement Account Could Shield You From Rising Tax Rates

Taxes are pretty much a part of life no matter your age. You could be 22 working your first job or 72 living largely on Social Security, and the IRS is still going to come after a portion of your income. 

But while having to pay taxes in your 20s can be burdensome in its own right, having to pay taxes in retirement can be all the more stressful. That's because you're living on a fixed income that may consist only of Social Security and savings. 

And adding to the stress is the potential for your tax rate to rise over time. One account, however, could make it so that rising tax rates, if they come to be, aren't a problem for you once you're no longer working, and are instead using your savings.

How tax rates work

The U.S. tax system is a marginal one that has you paying a higher rate of tax on your highest dollars of earnings and a lower rate of tax on your lowest dollars of earnings. Each year, the IRS establishes tax brackets based on income.

In 2024, for example, if you're single earning $11,601 to $47,150, you're in the 12% tax bracket, which means your tax rate is 12% on income within that range. You only pay 10% on your first $11,600 of income.

The highest tax rate you could be liable to pay today is 37%. That rate applies if you're single with an income of $609,351 or more.

But in time, the tax rates that apply today could change for the worse. Lawmakers could decide that single income falling between $11,601 and $47,150 is subject to a 15% tax rate, not 12%. They could also end up raising the top tax rate from 37% to a higher number -- say, 39%, or 41%, or even 45%. 

Let's say you save enough so you're able to withdraw $20,000 a year from your IRA in retirement and you also get $25,000 a year in Social Security. That's $45,000 in total. Assuming you're single, based on today's tax rates, you'd pay 12% on your highest dollars of earnings. But if your tax rate goes up in retirement, you take home less of your $45,000 annual income.

Now, you can't change the amount of tax you might end up paying on Social Security. But you can take steps to make sure you don't have to pay taxes at all on the money you withdraw from your retirement savings. 

It pays to save in a Roth IRA

If the idea of paying more tax in retirement scares you, then it pays to put your savings into a Roth IRA. A Roth IRA won't give you an upfront tax break on your contributions like a traditional IRA will. However, with a traditional IRA, you're paying taxes on the funds you remove in retirement. With a Roth IRA, you won't pay taxes on those withdrawals. And because of this, rising tax rates won't impact the income you get from your savings.

Let's say you're taking $20,000 a year out of a retirement plan. If it's a traditional IRA, your tax rate matters. With a Roth IRA, it really doesn't because you're not paying any tax on those withdrawals. So if you're currently in the 12% tax bracket and that gets bumped up to 15%, as far as your savings go, it's irrelevant. 

Of course, without a crystal ball, it's impossible to know which direction tax rates will move in by the time you reach retirement. But if you'd rather not worry about it, at least in the context of tapping your savings, then it makes sense to put your money into a Roth IRA.