A key concept in wealth building and retirement planning is the Three-Bucket System.

The overarching concept is to fill one bucket with pre-tax dollars (taxes not paid now but deferred until a later date), fill the second bucket with no-tax dollars (taxes paid now and no taxes paid at a later date), and fill a third bucket with after-tax dollars where taxes are paid now but future taxes will vary based a mix of tax aspects such as capital-gains rates and tax basis (the third bucket is represented by your typical brokerage investment account).

One of the most common and most consequential questions in retirement and tax planning is whether to make Roth (Bucket 2) or traditional (Bucket 1) contributions to retirement accounts such as IRAs and 401(k) plans. While the mechanics of each option are straightforward, the strategic implications can be complex and highly dependent on an individual’s tax profile, career trajectory and long-term financial goals.

This article focuses on the first two buckets and explores the key differences between Roth and traditional contributions and outlines practical strategies for determining which approach, or combination of approaches, may be most appropriate.

Traditional IRAs and traditional 401(k) contributions can be powerful tools, particularly for taxpayers in current higher tax brackets. Key advantages include immediate tax deduction (subject to income and plan participation limits for IRAs), lower current taxable income (which may also reduce phaseouts or surtaxes), and tax-deferred compounding over long periods.

However, there are important considerations as follows: Withdrawals in retirement are fully taxable at ordinary income rates; Required Minimum Distributions (RMDs) apply starting at age 73 (under current law); and large traditional balances can increase future marginal tax rates, Medicare premiums (IRMAA) and taxation of Social Security benefits.

In summary, traditional contributions are often most attractive when a taxpayer reasonably expects to be in a lower tax bracket in retirement than during their working years.

Roth IRAs and Roth 401(k)s reverse the tax equation by requiring tax payment upfront. Key advantages include: tax-free qualified withdrawals in retirement; no RMDs during the owner’s lifetime for Roth IRAs; greater flexibility for tax planning, estate planning and legacy goals; and protection against future tax-rate increases.

Potential drawbacks to Roth IRAs include: no current-year tax deduction; income limits for direct contributions; and paying tax today may be costly for high-income taxpayers in peak-earning years.

Roth contributions are especially appealing for individuals who expect equal or higher tax rates in retirement, or who value tax diversification and certainty.

There is no universally “correct” choice between Roth and traditional contributions. Instead, the decision should be strategically informed by five key variables as follows:

1. Current vs. Future Marginal Tax Rates: This is the most cited, and often oversimplified, factor. While many assume retirement equals lower taxes, that is not always the case, particularly for high-net-worth individuals with pensions, rental income or large required distributions.

2. Career Trajectory and Income Growth: Younger professionals early in their careers may benefit from Roth contributions when income and tax rates are relatively low. As earnings increase, shifting toward traditional contributions may become more advantageous.

3. Legislative Risk: Tax laws change. Roth accounts hedge against future increases in income-tax rates by locking in today’s known rates.

4. Required Minimum Distributions and Medicare Costs: Large traditional balances can push retirees into higher brackets and increase Medicare Part B and D premiums. Roth assets can be used strategically to manage taxable income in retirement.
5. Estate and Legacy Planning: Roth accounts are particularly attractive for heirs. Beneficiaries receive distributions tax-free (though still subject to distribution timing rules), making Roth assets a powerful legacy tool.

For many taxpayers, the optimal approach is not an “either/or” decision, but a blend of Roth and traditional contributions over time.

A diversified tax strategy allows retirees to control taxable income year by year, fill lower tax brackets with traditional distributions, use Roth withdrawals to avoid pushing income into higher brackets, and better manage taxation of Social Security and Medicare premiums.

This flexibility is often undervalued but can significantly improve after-tax retirement outcomes.

Beyond annual contributions, Roth conversions play a central role in advanced retirement planning. Converting traditional assets to Roth during lower-income years, such as early retirement before Social Security and RMDs begin, can reduce lifetime tax liability.

Conversions require careful modeling, as the upfront tax cost must be weighed against long-term benefits. However, for many clients, strategic conversions are one of the most effective tools available.

The decision between Roth and traditional retirement contributions is ultimately a tax planning decision, not merely an investment choice. It requires a forward-looking analysis of income, tax rates, legislative risk and personal goals.

As with most sophisticated financial strategies, the most effective solutions are customized, revisited regularly and coordinated with broader tax and retirement planning.

Working with a qualified CPA or tax advisor can help ensure that retirement contributions align not only with today’s tax return, but with long-term financial security.