If you’ve been a good saver, there’s a number in your retirement accounts that probably feels reassuring. The balance on your 401(k) or traditional IRA statement looks like your money. It isn’t — not entirely. A portion of every dollar in a pre-tax retirement account belongs to the IRS. You’ve deferred that bill, not eliminated it. And depending on how large those accounts grow, the eventual tab can be significant.
Most people don’t think about this until the IRS requires them to. By then, the options narrow considerably.
What is a deferred tax liability in a retirement account?
A deferred tax liability is the tax you’ll owe when you withdraw money from a pre-tax account. Every dollar you contributed went in untaxed. Every dollar of growth accumulated untaxed. But ordinary income tax applies when the money comes out — and withdrawals are required starting at age 73 under current IRS rules.
How big is that hidden liability?
It depends on your marginal tax rate at withdrawal and the size of the account. On a $1,000,000 balance, a 22% marginal rate means roughly $220,000 owes to taxes over time. At 32%, that’s $320,000. The account balance overstates your actual wealth.
Can you reduce the deferred tax liability before retirement?
Yes. The primary tool is a Roth conversion — moving money from a traditional IRA or 401(k) into a Roth account, paying tax now at your current rate. There’s no annual limit on conversion amounts under IRS rules, though the converted amount is treated as ordinary income in the year of conversion.
When is the best time to do Roth conversions?
Generally in the years between retirement and age 73, when income often drops before required minimum distributions begin. That window is when your marginal rate may be the lowest it’ll ever be during retirement.
What is the hidden tax cost in retirement accounts?
When you contribute to a 401(k) or traditional IRA, you get a tax deduction today. The government essentially becomes a silent partner in your account. The partnership terms: they don’t take their cut now. They take it later, on your terms — sort of.
The IRS sets the schedule through required minimum distributions. Starting at age 73, you’re required to withdraw a minimum amount each year based on your account balance and a life expectancy factor from IRS Publication 590-B. The factor at age 73 is 26.5, meaning a $2,000,000 IRA requires a minimum withdrawal of roughly $75,472 in year one. That distribution is fully taxable as ordinary income, regardless of whether you need the money.
The table below shows how the deferred tax liability changes the real after-tax value of a traditional IRA balance, depending on the marginal rate you expect in retirement.
| Pre-Tax Balance | 22% Marginal Rate | 24% Marginal Rate | 32% Marginal Rate | 37% Marginal Rate |
|---|---|---|---|---|
| $500,000 | $390,000 | $380,000 | $340,000 | $315,000 |
| $1,000,000 | $780,000 | $760,000 | $680,000 | $630,000 |
| $1,500,000 | $1,170,000 | $1,140,000 | $1,020,000 | $945,000 |
| $2,000,000 | $1,560,000 | $1,520,000 | $1,360,000 | $1,260,000 |
Estimates assume all assets withdrawn at the stated marginal rate. Actual tax liability varies based on filing status, deductions, state taxes, and distribution timing. Not a tax projection.
A $2,000,000 IRA at a 32% marginal rate has an after-tax value closer to $1,360,000. The $640,000 difference is the deferred tax liability — money that appears on your statement but will belong to the IRS.
Large pre-tax balances also trigger additional costs. Medicare Part B and D premiums are means-tested through IRMAA (Income-Related Monthly Adjustment Amount). In 2026, married couples filing jointly with income above approximately $218,000 pay surcharges on top of standard Medicare premiums, according to the Centers for Medicare & Medicaid Services. RMDs can easily push a retiree into that threshold.
The planning window most people miss
There’s usually a gap between when someone retires and when RMDs begin. For a person who retires at 62, that’s up to 11 years. For someone at 65, it’s 8 years. During that window, earned income often drops — which means the marginal tax rate often drops too.
Income in this window can often be managed intentionally.
That’s where Roth conversions become a meaningful planning tool. A Roth conversion moves money from a pre-tax account to a Roth account. You pay ordinary income tax on the converted amount in the year of conversion. From that point forward, qualified distributions from the Roth are tax-free — including growth.
There’s no limit on how much you can convert in a given year under IRS rules. The only constraint is the tax bill that conversion creates. Done in a low-income year, you can fill up lower tax brackets at rates that may be unavailable once Social Security, pensions, and RMDs all kick in simultaneously.
The table below compares two approaches for a 62-year-old with a $1,500,000 traditional IRA and no other income between 62 and 72.
| Scenario | Annual Action | Balance at 73 (Approx.) | Year-1 RMD | RMD Taxable | 10-Year Cumulative RMD Tax (24% Rate) |
|---|---|---|---|---|---|
| No conversion | Nothing | $2,415,000 | $91,132 | Fully taxable | ~$218,000 |
| Convert $80K/year | Pay tax on $80K/yr | $1,650,000 pre-tax + $850,000 Roth | $62,264 (pre-tax only) | Partially taxable | ~$149,000 |
Assumes 5% average annual growth. Tax estimates use 24% marginal rate on taxable distributions. For illustration only — not a tax or financial projection.
Converting $80,000 per year for 10 years moves approximately $800,000 out of the taxable account. The tax paid during the conversion years is real — but it’s paid at the current rate, not the potentially higher rate that applies when RMDs begin and Social Security adds to the income stack.
The math most people haven’t run on their own accounts
Most people know Roth conversions exist. Fewer have actually run the numbers on their own situation.
The key variables are the marginal rate during the conversion window, the expected marginal rate in retirement, and the account growth rate between now and RMD age. If those rates are roughly equal, conversion doesn’t create much benefit. If the conversion rate is meaningfully lower than the expected retirement rate, the math often favors converting.
Two scenarios where the conversion window is particularly valuable:
First, a high earner who retires early. Pre-retirement income was in the 35–37% bracket. In the first years of retirement, before Social Security and before RMDs, taxable income may drop to the 22–24% range. That rate differential is the opportunity.
Second, a person with a large traditional IRA and modest other income. RMDs will eventually force large distributions regardless of need. Getting ahead of those distributions — converting at lower rates before they’re mandated — reduces the lifetime tax bill on the account.
The IRS doesn’t care about your financial plan. It cares about the RMD schedule. If you haven’t run projections on what your RMDs look like at 73, 75, and 80 — and what those distributions do to your marginal rate, your Medicare premiums, and your taxable income — that’s the calculation worth doing now.
The account balance on your statement is a gross number. The after-tax number is what you can actually spend. For most people with substantial traditional IRA or 401(k) balances, those two numbers are further apart than they realize.
The information provided is for educational purposes only and should not be construed as investment advice. Investment strategies should be tailored to individual circumstances, risk tolerance, and goals. Past performance doesn’t guarantee future results. Consult with qualified financial professionals regarding your specific situation.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Great Valley Advisor Group, a registered investment advisor and separate entity from LPL Financial.
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