Financial services company Empower says there are 937,747 Americans who are 401(k) millionaires – up 18% from last year. The average balance in these accounts is $1.14 million.

But author and retirement tax expert Ed Slott has a warning for those millionaires: many aren’t really millionaires. Or at least you won’t be once you pay your taxes.

In his Book, “The Retirement Savings Time Bomb,” Slott warns that there is a tax trap awaiting millions of people with traditional IRAs and 401(k)s. His warnings intensified in his new book, published in June, “The Retirement Savings Bomb Ticks Louder.”

Slott, named the “Best Source for IRA Advice” by the Wall Street Journal, says the problem, or “tax trap,” is that people tend to forget that traditional retirement accounts are “tax-deferred,” not tax free. “Remember, all of this money has not yet been taxed in IRAs and 401(k)s,” he says.

The taxes for many will begin when you start making withdrawals, which are now required once the accountholder turns 73. But many people begin withdrawals earlier. Those taxes can be thousands of dollars, depending on your tax bracket. In anticipation, some 401(k) plan administrators automatically withhold 20% of withdrawals to cover those unpaid taxes.

Withdrawals from these retirement accounts are taxed as ordinary income, in addition to other income you have in that year. Historically, it has been assumed that withdrawals from IRAs and 401(k)s would be made after retirement, when your income would be lower. But today, people are living longer and working longer, so that isn’t always the case.

The Answer: Convert to Roth Accounts

Slott’s answer is to begin converting those traditional IRAs and 401(k) to Roth accounts.

Traditional retirement accounts are tax-deferred, which means the account holder doesn’t pay taxes until he makes a withdrawal. There are also tax advantages for contributions.

With a Roth, you contribute after-tax dollars. There are no current-year tax benefits, but your contributions and earnings can grow tax-free. And you can withdraw them tax-free and penalty free after age 59½ and once the account has been open for five years.

That brings us to the key in Slott’s strategy. He says, “always pay taxes at the lowest rate.” And for many, that means begin converting those traditional tax-deferred accounts to Roth accounts.

“It’s very simple,” Slott says. “It’s like getting taxes on sale. Everybody likes a sale in a store. Look at Black Friday. They trample people to death to save $10 on a TV or something. The difference is, the sale on something in the store, you don’t actually have to buy that thing. But with taxes, you do. It’s not if, but when, these taxes will have to be paid. So, you may as well get them on sale, which is right now.”

Adding to that urgency is the fact that the Tax Cut and Jobs Act of 2017 expires next year. That law featured lower tax brackets and a lower standard deduction. Historically, U.S. Tax rates have been much higher. Slott points to a chart in his book that shows the nation’s top tax rates were as high as 91% the 1960s and 70% in the 1970s

There are incentives to encourage people to save for retirement in tax-deferred accounts. But the government wants you to eventually to pay those deferred taxes. So, they require you to begin withdrawals, called Required Minimum Distributions, or RMD. The RMD age requirement had been 70½ since 1986. The age was increased to 72 with the SECURE Act in 2019 and increased again to 73 with SECURE Act 2.0 in 2023.

But Slott says if you wait until you turn 73 to begin thinking about those withdrawals, you are no in longer control of your tax destiny.

“You want to be able to control the taxes you pay,” he says. “That’s how you can manage your tax bill to keep more money in retirement. You can do that by taking money out now, even if you don’t have to, just to maximize to take advantage of those low bracket rates and then move it to Roth IRAs. If you don’t need it this is the way to grow income tax free for the rest of your life.”

Penalties for not taking your RMD or taking less than required are severe. They were up to 50% of the amount or your RMD. That maximum penalty was reduced to 25% in the Secure Act 2.0.

Slott’s advice: “Pay taxes now at, today’s low rates. Why doesn’t everybody do it? Because most people are short sighted. Nobody wants to pay a tax before they’re forced to. But if you take that point of view, you lose control, and then you have bigger tax bills in retirement. Every day that your IRA grows, part of it is growing for the Uncle Sam. I always say in my seminars, your IRA is a debt. Your IRA is an IOU to the IRS.”

YOUR TURN

Are you prepared for the retirement tax bomb? Share your thoughts in the comments!

Rodney A. Brooks is an award-winning journalist and author. The former Deputy Managing Editor/Money at USA TODAY, his retirement columns appear in U.S. News & World Report and Senior Planet.com. He has also written for National Geographic, The Washington Post and USA TODAY and has testified before the U.S. Senate Special Committee on Aging. His book, “The Rise & Fall of the Freedman’s Bank, And Its Lasting Socio-economic Impact on Black America” was released in 2024. He is also author of the book “Fixing the Racial Wealth Gap.” His website is www.rodneyabrooks.com

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