In very general terms, the best years to contribute to a Roth IRA, Roth 403(b), or Roth 401(k) are years when your income tax rate today is lower than your income tax rate will be when you retire. There are two ways this can happen, either (1) your taxable income is higher in retirement than it is today or, (2) income tax rates are higher in your retirement years than they are today.
Many financial pundits say that most people’s income is lower in retirement than it is when they are working. But as a retiree myself, I think it is better to save so that your disposable income in your retirement years is higher than during your working years. The reasons why I believe this is that when you are retired, you want to have the resources to do all of the things that you didn’t have time to do when you were working such as travel, take up new hobbies, buy a boat, buy a retirement home, etc. Additionally, healthcare costs increase exponentially such that the average healthcare expenditures for an 85-year-old is $46,500 per year whereas healthcare expenditures for a 40-year-old is only $8,600. Americans need sufficient annual retirement income to cover these increasing healthcare costs. Assuming tax rates remain constant, good years to contribute to a Roth account are:
- Early in your career when your salary is relatively low before you get promotions or gain seniority
- Years when you are off work or working part-time for a few months, resulting in a lower annual income
- When you plan on retiring late in life, resulting in a large amount of retirement savings and thus a high annual retirement income
- If you anticipate a large taxable inheritance during your retirement years, such as an inherited tax-deferred IRA or annuity
Federal personal income tax rates are at historic lows at present. The big question is will they remain low or will Congress increase personal income tax rates in the future? It takes a lot of money to run the federal government and the way governments get money is through taxes. If any government lowers or eliminates income taxes, it has to increase other types of taxes, like excise taxes, capital gains taxes, property taxes, sales taxes, or tariffs. It is kind of like the whack-a-mole carnival game.
Last year, Congress voted to continue the 2016 federal income tax cuts. In order to do this, the government reduced expenses by laying off a large number of government employees and eliminating a large number of federal grants and programs. Reducing expenses alone was not sufficient to permit the low income tax rates, so the President instituted sweeping import tariffs, which are consumption taxes paid by American consumers who purchase products and supplies that originate from other countries – essentially a sales tax on anything that is not manufactured or produced in the United States.
Government spending will rise in the future
The largest federal government expenditures are Medicare & Medicaid (24%), Social Security (22%), interest (14%), and defense (13%). Together, these 4 spending categories account for nearly three-quarters of the annual U.S. budget. Eliminating or cutting back on other federal programs is great for scoring political points but in reality has a negligible effect on the federal budget. There are reasons to believe that none of these four major categories of government spending will decrease in the near future:
Medicare and Medicaid
There are two reasons to believe that Medicare and Medicaid expenditures will rise in the future: healthcare inflation and the aging U.S. population. American healthcare is expensive and increases significantly with age, averaging $26,490 per year for Americans between 65-84 and $46,506 for Americans over age 85-years-old.
Historically, healthcare costs has risen faster than the general inflation rate. Between 2000 and 2023, healthcare costs increased by 121% whereas the cost of all goods and services in the U.S. increased by 86%. Assuming this trend continues for the next 10 years, the cost to provide healthcare to all Americans will continue to outpace the country’s overall inflation rate.
The U.S. population is aging due to a longer life expectancy and a decreased birth rate. In 1960, the U.S. birth rate was 3.7 children per every American woman. In 2024, the birth rate had fallen to the lowest in history at 1.6 births per woman. This declining birth rate has resulted in fewer young Americans compared to elderly Americans. At the same time, Americans are living longer. After a drop in life expectancy during the COVID pandemic, U.S. life expectancy reached an all-time high in 2024 at 79.0 years. The net result is that the number of retired Americans is increasing relative to the number of working Americans.
Medicare is paid for by both payroll taxes and U.S. government general funds. Payroll taxes that you pay during your working years are not saved in an account somewhere to cover your Medicare expenses later in life. Instead, Medicare costs of today’s retirees are paid by today’s U.S. workers’ payroll taxes. But Medicare is also funded by government general funds and the source of those general funds is federal taxes. As the percentage of Americans over age 65 increases at the same time that the healthcare inflation rate increases, it will put increasing demand on a shrinking percentage of American workers to pay for Medicare through taxes. The bottom line is that the federal government will have to increase some form of taxes to pay for the future increased cost of Medicare.
Social Security
Medicare and Social Security are both funded through payroll taxes. Thus, the declining U.S. birth rate and increasing U.S. life expectancy are affecting Social Security in the same way that they are affecting Medicare. Previous estimates were that the Social Security Trust Fund would run out of money in 2033. Yesterday, the Congressional Budget Office released projections that the Social Security Trust Fund will be depleted sooner than previous estimated, in 2032. The main reason for this is that the CBO revised its economic forecast and now predicts a higher inflation rate than it previously predicted. Because the annual cost of living increase in Social Security benefits is tied to inflation, if inflation rises, so too do Social Security expenditures. Once the Social Security Trust Fund is depleted, monthly Social Security checks will be reduced to equal the amount taken in by payroll taxes each year. Current payroll tax rates will only provide enough money to pay for 81% of future Social Security monthly benefit checks. Therefore, beginning in 2032, the federal government will only have two options: either reduce Social Security benefits by 19% or increase taxes to maintain current Social Security benefits.
Interest payments
The interest rate that the federal government pays on Treasury bonds, notes, and bills is tied to the Federal Reserve’s lending rate. In turn, the main driver of the lending rate is the nation’s inflation rate. Although inflation has cooled since the supply chain disruption caused by the COVID pandemic, it has stubbornly remained above the Federal Reserve’s annual inflation target of 2.0%. One of the main reasons for the persistently high inflation rate this year is tariffs being charged on goods and products imported from other countries. Tariffs are essentially a sales tax on imports that are ultimately paid by American consumers, thus raising the prices of anything manufactured abroad or made from products and natural resources produced abroad.
There are two ways to reduce the amount that the federal government pays for interest: either lower the Federal Reserve’s lending rate or stop borrowing money. The Federal Reserve is currently opposed to reducing the lending rate because rate reductions will worsen inflation. The federal government cannot stop borrowing money because it is spending more than it takes in from taxes and tariffs. Therefore, the government is stuck with having to borrow more and more money at high interest rates. This will grow the amount that the Federal government must pay each year in interest. To make matters worse, as the U.S. deficit increases, its credit rating will eventually fall, resulting in even higher interest rates that the government must pay to borrow more money.
Defense spending
The United States spends slightly less on defense each year than it does on interest. However, the U.S. prides itself on the most powerful and technologically sophisticated military in the world. The U.S. uses the threat of its military for geopolitical leverage. To cut back on military spending would be to allow other world powers, such as China, to overtake the U.S. in military clout. The Congressional Budget Office projects that defense spending will increase by 1.1% between 2025 and 2029 (adjusted for inflation) and then increase a whopping 11% between 2029 and 2039 (also adjusted for inflation). Thus, not only will defense spending not be lower in the future but it will actually be a lot higher in the future.
If the government can’t reduce spending, it will have to increase taxes
With 73% of U.S. government spending most likely to increase, rather than decrease, the only way to avoid spiraling federal debt will be to increase taxes.
Data from the U.S. Department of the Treasury reports that individual tax accounts for the largest percentage of federal revenue at 52%. The vast majority of individual tax is the personal income tax accounting for 91% of individual tax; capital gains tax accounts for about 9% of individual tax. Payroll tax is the second largest income source at 32% and is taxed at 15.3% of gross income with half paid by the employer and half paid by the employee. Payroll taxes only apply to the first $184,500 of gross income – any amount above that is not subject to payroll tax. Tariffs account for 7% of government revenue and are applied to imported goods and products. Corporate income tax accounts for 6% of government revenue and is a flat 21% of corporate profits (gross revenue minus expenses and deductibles). Excise tax is a form of sales tax charged on things like alcohol, gasoline, tobacco, and airline tickets. Estate and gift taxes account for <1% of government revenue and are charged on inherited estates greater than $13.61 million (individual) or $27.22 million (married couples). Gift taxes are levied on annual gifts exceeding $19,000 (individual) or $38,000 (married couples). Estate and gift tax rates range from 18% to 40%.
Tariffs and excise taxes are “consumption” taxes, similar to sales taxes levied by states and local communities. Personal income tax and payroll tax are both types of income tax that are paid by the individual worker and based on the amount that you earn. Corporate income tax and individual capital gains tax are very different from personal income tax in that they only apply to profits – either corporate profits or personal profits from asset sales. Because of this, corporate income tax is ultimately paid by investors in the way of reduced dividends and by consumers in the way of higher prices for the products produced by the corporations. Capital gains tax is simply paid by the individual investor.
Over the past 50 years, the percentage of total federal government revenue from payroll taxes has grown while the percentage from excise taxes and corporate income taxes has fallen. The percentage from individual income taxes has also grown, albeit at a much slower rate than payroll taxes.
Roth retirement accounts and taxes
If the federal government increases personal income tax rates in the future, then investing in Roth accounts now is advisable. But increasing any other type of tax will not affect Roth accounts. Payroll taxes paid by the individual are always paid in the year that you earn money, even if that money then goes directly into a tax-deferred retirement plan such as a 401(k) or 403(b) and thus are not at all subject to the financial forces that govern the decision of whether to contribute to a tax-deferred retirement account or a Roth retirement account. Similarly, capital gains tax is only paid on non-retirement investments and does not affect the decision about whether to contribute to a tax-deferred or Roth retirement account.
The impact of increasing different types of federal taxes
Increasing payroll taxes or increasing the maximum income subject to payroll taxes can help keep Medicare and Social Security solvent but will not help cover the increasing federal expenditures on interest and defense spending.
Increasing capital gains tax rates could be applied to increased interest spending and increased defense spending but capital gains accounts for only a very small amount of total government revenue – about 4.6%. Therefore, capital gains taxes would need to be increased to astronomical levels to make up for the projected increases in government spending on interest and defense.
Increasing tariffs could be applied to interest and defense spending but tariffs would need to be dramatically increased. Like any consumption tax, tariffs are inflationary in the short term and this could potentially result in higher interest rates and thus more money that the government has to pay for interest payments to borrow money. However, because tariffs cause a one-time increase in the price of imported goods and products, they have relatively little impact on long term inflation. Another problem with tariffs is that they encourage consumers to buy domestically produced goods and products so that over time, American consumers buy less imported goods and products, thus reducing the amount of money that the federal government brings in from tariffs.
Increasing corporate income tax could be applied to future increased government spending. However, when corporations are faced with increased tax expenses, they either have to reduce dividends paid to investors or increase the cost of goods and services sold. Last year, U.S. corporations distributed $2.26 trillion in dividends. The government collects a total of $5.23 trillion in revenue each year so increasing the corporate income tax rate would seem to be a viable option to solve the looming U.S. debt. Especially because foreign investors own approximately 40% of U.S. stocks, meaning that foreign investors receive about 40% of the dividends from U.S. companies. However, not all corporations distribute dividends, so increasing the corporate income tax rate to 25% or 30% would likely result in increased costs of goods and services purchased by consumers. In other words, inflation.
Excise tax is a type of sales tax ultimately paid by consumers. Currently, the amount of revenue from excise taxes is so small that to cover the looming deficit, the federal government would need to start taxing other goods and services, in essence instituting a national sales tax, similar to the “value added tax” used by 160 different countries. The value added tax used in European Union countries averages 22% and the value added tax used in the U.K. averages 20%. Excise tax and sales tax cause a short term increase in inflation but have little impact on long term inflation.
Estate and gift taxes account for such a small amount of government revenue that any realistic increase in these taxes would have a negligible impact on the federal deficit.
Trying to predict the future
From the above discussion, it is clear that the federal government will need to increase some form(s) of taxes in the near future in order to pay for the projected increases in Medicare, Social Security, defense, and interest spending. The big question is which types of taxes will be increased? Increasing consumption taxes such as tariffs, excise taxes, or a national sales tax would likely be favored by conservatives. Increasing individual income tax rates and corporate income tax rates (particularly on high earners and large corporations) would likely be favored by liberals. Consumption taxes disproportionately affect lower income people whereas income taxes disproportionately affect higher income people.
If the government increases individual income tax rates in the future, then now is a great time to put money in a Roth 401(k), Roth 403(b), or Roth IRA. If the government increases other kinds of tax, then there will be no impact on whether or not to contribute to a Roth retirement account. Does the United States have the stomach for returning to the pre-2016 personal income tax rates? Or will the U.S. increase some other form of tax?
What is clear is that the rates of some type or types of tax are going to have to increase between now and when most working Americans eventually retire.
The safest approach for the prudent investor is to contribute to both tax-deferred retirement accounts and Roth retirement accounts this year. That way, you hedge your bets on whether your personal income tax rate will be higher or lower in retirement than it is today. If political sentiment seems to be shifting toward increasing the personal income tax rate, then change your strategy and put as much money as you can in Roth accounts before the higher tax rates are instituted. If, on the other hand, political sentiment seems to be to increase consumption taxes or corporate income taxes, then the decision about whether to contribute to a tax-deferred or Roth retirement account should be based on your assessment of whether your taxable income today is likely to be higher or lower than your taxable income in retirement. By contributing to both tax-deferred and Roth retirement accounts, you create a diversified retirement portfolio and a diversified portfolio is the strongest portfolio you can build.
Create a diversified retirement portfolio
Your retirement portfolio should be diversified by having money in five different types of accounts:
- Fixed income. This includes Social Security benefits, pension income, and annuities.
- Tax-deferred. This includes a regular 401(k), 403(b), 457, traditional IRA, and SEP.
- Roth. This includes a Roth 401(k), Roth 403(b), and Roth IRA. Not all employers offer a Roth 401(k) or Roth 403(b) and if your income is too high, you cannot directly contribute to a Roth IRA. However, anyone can contribute to a traditional IRA and then do a “backdoor Roth” by then immediately converting that money into a Roth IRA.
- Regular investments. These are investments that you make with your post-tax income such as mutual funds or stocks from a brokerage account. This could also include investment possessions such as gold, art, or real estate properties.
- Cash. This includes money held in your checking, savings, or money market accounts. Holding a lot of money in cash is a poor choice for long term investing because it will lose money compared to inflation. However, even in retirement, it is desirable to keep a cash emergency fund sufficient to cover at least 3 and preferably 6 months of basic expenses in case of unexpected large expenses or a sudden dramatic fall in the stock and bond markets.
By having your retirement portfolio split between these 5 buckets, you can strategically withdraw from different buckets depending on how the market is doing and what the income tax rates are in any given year of retirement. This then allows for maximal annual disposable income while maximally preserving portfolio principal.
February 25, 2026
