This retirement account is an ‘IOU to the IRS’ — but here’s when it makes sense, expert says

When saving for retirement, it’s easy to funnel money into a pre-tax 401(k) plan or individual retirement account without planning for future taxes. Those pre-tax funds, however, can be handy in some cases, experts say.

Often, investors roll pre-tax 401(k) accounts into traditional IRAs, and the withdrawals in retirement trigger regular income taxes, depending on your tax bracket.

“Your IRA is an IOU to the IRS,” certified public accountant Ed Slott said during a session last week at the Horizons retirement planning conference in Coronado, California.

With uncertain future tax rates, Slott pushes for savings in after-tax Roth accounts, which won’t incur taxes in retirement. He also likes to use Roth conversions.

Roth conversions move pretax or nondeductible IRA funds to a Roth IRA, which can kick-start tax-free growth after an upfront tax bill.

However, there are scenarios where keeping some money in your pre-tax IRA makes sense, Slott said.

Certified public accountant Jeff Levine agreed. He told CNBC he prefers some “dry powder” — pre-tax money in retirement accounts that can be strategically withdrawn for planning opportunities.

By comparison, “you’ve already paid your tax bill” with after-tax Roth accounts, he said.

One tax planning opportunity is for retirees expecting long-term care expenses, experts say.

A 2022 research brief from the Department of Health and Human Services found 56% of Americans turning 65 that year will develop a condition that requires long-term care services.

Whether it’s in-home health aids or assisted living facilities, long-term care expenses are rising, according to Genworth’s annual survey.

But the medical expense deduction could help offset those costs, according to Levine. For 2025, you can claim the tax break for expenses that exceed 7.5% of your adjusted gross income for the year.

If you itemize tax breaks, the deduction reduces the amount of your income subject to tax. That means part of the medical expense deduction could be lost if your income is too low.

“You wipe it out,” Levine said.

But that issue could be solved with a large pre-tax IRA withdrawal in the year of high long-term care expenses, which boosts your adjusted gross income for that year, he said.

There’s another tax planning opportunity for investors with pre-tax IRAs who want to give to charity, Slott said.

Slott was referring to qualified charitable distributions, or QCDs, which are direct transfers from an individual retirement account to a non-profit organization. You must be age 70½ or older to qualify for a QCD.

While there’s no tax deduction for a QCD, the transfer is excluded from your income, meaning it won’t boost your adjusted gross income.

If you want to leave assets to charity and adult children after death, pre-tax IRAs are less attractive for your heirs because they must follow the “10-year rule,” and empty accounts within 10 years of the original owner’s death.

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