Personal Finance

I'm looking to save $2.5 million in order to spend $100k in retirement - how should I factor in future taxes?

Maurie Backman

Published: January 10, 2025 1:22 pm

Key Points from 24/7 Wall St.

• If you use the 4% rule to manage a $2.5 million nest egg, you’ll get about $100,000 in annual retirement income.
• That income may be taxable, depending on where you’re housing your savings.
• You may want to consider a Roth conversion ahead of retirement to minimize your future tax hit.
• Retiring early is possible, and may be easier than you think. Click here now to see if you’re ahead, or behind. ^(Sponsor)

A recent Northwestern Mutual survey found that Americans think it’ll take $1.46 million to retire securely. So if you’re aiming to retire with $2.5 million, it should buy you even more leeway to enjoy your golden years to the fullest.

That’s the amount of money one Reddit user is aiming for. They’re figuring that if they manage to amass a $2.5 million portfolio, that’ll translate into about $100,000 of annual income. And that’s accurate if they use the famous 4% rule.

Of course, there are some drawbacks of the 4% rule to know about, so it’s best to discuss different withdrawal strategies with a qualified financial advisor. But one thing this Redditor is concerned with is taxes, and understandably so.

Factoring taxes into your retirement

Figuring out what your tax burden will look like in retirement can be tricky for one big reason — we can’t see into the future and therefore don’t know what tax rates will look like down the line. Because of this, it’s important to plan carefully to minimize your senior tax bill. And a big part of that boils down to choosing the right home for your retirement savings.

If you save in a traditional IRA or 401(k) plan, you’ll get an immediate tax break on the money you contribute. You’ll also enjoy tax-deferred gains. However, come retirement, your withdrawals will count as taxable income. That could create a scenario where you’re not only on the hook for a higher IRS bill, but you’re also looking at paying taxes on your Social Security benefits and facing surcharges on your Medicare premiums.

For this reason, I would suggest keeping at least a portion of your long-term savings in a Roth IRA or 401(k), where your withdrawals will be tax-free later in life. If you’re saving in an employer plan that has a Roth option, it won’t matter if you’re a higher earner or not — the Roth should still be available to you if it’s a feature of your company’s plan. If you’re limited to an IRA and earn too much to contribute to a Roth directly, you could always do a Roth conversion ahead of retirement.

Having funds in a Roth account offers the added benefit of not being forced into taking required minimum distributions. That buys you the leeway to leave your money to sit and grow if there are years when you don’t need to withdraw as much.

Look at the big picture

Your goal doesn’t necessarily have to be to pay zero taxes in retirement. But at a time when you’re living off of savings, it helps to minimize your tax burden as much as possible.

Of course, the tricky thing about doing a Roth conversion ahead of retirement is that if you’re a higher earner, you may be moving that money over at a time when you’re in a higher tax bracket. This means your conversion might cost you more than you’d like it to.

For this and other reasons, it’s a good idea to consult a financial advisor. They can help you figure out the best strategy based on your personal situation and work to help set you up with the retirement income you want.