Three Types of Money: And Why You Probably Only Have One

Week 3  |  The Missing Chapter  |  April 2026

A couple I recently started working with are a few months from retirement. Decades of consistent saving, a paid-off house, no debt, a retirement income they can live on comfortably. By the numbers, they are in good shape.

They had also been putting off home updates for a while, the way most people do during the busy years. Now, with retirement a few months out, the project had become both timely and necessary. Getting up and down the stairs had gotten harder as they had gotten older. The renovation would make the house safer and easier to move through. They wanted to stay in that house as long as they could, and doing it now, while they had the energy to manage a construction project, made more sense than waiting.

When we started working together and looked at how to fund it, we ran into a constraint.

Nearly every dollar they had saved over their careers was in traditional retirement accounts. The 401(k)s, the rollover IRAs, all of it pre-tax, all of it tax-deferred. They had started doing Roth conversions the year before, converting a modest amount each year to stay within the 12% bracket. Smart move, right direction. But one year of conversions does not build a balance you can draw on for something like this. The Roth account existed. It just did not have enough in it to matter yet.

They could wait. Let the conversions accumulate for a few more years, build up enough Roth dollars to fund the project more efficiently, and do the renovation then. Financially, that was probably the cleaner path.

But they did not want to wait. The house was getting harder to navigate now. The renovation was not a someday project anymore. And the frustrating part, the part worth understanding, is that the constraint they were facing was not the result of anything they had done wrong. It was the result of an architecture that accumulated entirely by default, over decades, without anyone ever showing them that it would matter at a moment exactly like this one.

The renovation was going to cost $150,000.

The math that surprised them

Their taxable income in retirement, after Social Security, a small pension, and all applicable deductions, came out to about $83,000. That left $13,950 of room in the 12% bracket before hitting the 22% threshold at $96,950. Every dollar above that line is taxed at 22%.

Here is the question worth asking before looking at any numbers: they need $150,000 to pay the contractor. Not $150,000 gross out of the account. $150,000 in their pocket, after taxes. Those are two different numbers, and most people do not think about them separately until they are sitting in front of a withdrawal form.

So how much did they actually need to pull?

$190,519.

More than $40,000 of that withdrawal went straight to taxes. Of the $176,569 that crossed into the 22% bracket, every dollar cost 10 cents more in federal tax than it would have at 12%, an additional $17,657 simply because they had no other bucket to draw from. If the renovation ran over budget, every extra dollar was in the 22% bracket too.

These figures reflect federal income tax only and do not account for state income taxes, which would require an even larger gross withdrawal for clients in states where income is taxed.

The obvious escape hatch

Finance it. Don’t pull from retirement accounts at all. Take out a HELOC and keep the tax picture clean.

It is a legitimate option, and the math may be more favorable than you would expect.

The cleanest way to frame it is what I think of as the 150-to-150 comparison: borrow the $150,000 you need against your home, versus withdrawing enough from the traditional IRA to net $150,000 after taxes. You have already seen what that withdrawal costs: $190,519 gross, $40,519 in federal income tax. That is the number the HELOC has to beat.

At current rates, it typically does.

There is one more variable the table does not capture: the money that stays in the IRA keeps earning returns. Fixed income investments in a traditional IRA earn a nominal rate that includes an inflation component, typically somewhere in the range of 4 to 6 percent. If you are borrowing at 7 percent and the retained balance is earning 5 percent, the true net cost of the HELOC is closer to 2 percent. The HELOC interest and the IRA return are running in opposite directions, and the IRA return meaningfully narrows the effective cost.

The HELOC also offers something the IRA withdrawal cannot: flexibility. The loan can be structured for a one-year payoff if cash flows allow it, or stretched further if needed. The optimal path for most people navigating this situation is to continue maximizing Roth conversions up to the top of the 12 percent bracket each year, filling every dollar of that window, while directing available cash flows toward paying the loan down as aggressively as possible. Conversions and repayment run in parallel. The tax-free bucket keeps building. The loan shrinks. The two goals do not have to compete with each other.

There is rate risk worth acknowledging. HELOCs are typically variable-rate products, which means costs can rise if rates move higher. But rates can also fall, which would reduce the effective cost further.

One additional option worth knowing about, particularly for anyone with meaningful assets in a taxable brokerage account: a Pledged Asset Line, or PAL. Similar in concept to a HELOC, a PAL lets you borrow against your investment portfolio as collateral instead of your home. The securities stay invested and continue earning returns. The loan proceeds are not a taxable event. Nothing gets sold. For clients with sizable taxable account balances, a PAL can sometimes be the cleanest path of all.

All of that said, and here is the honest conclusion: even when the math points toward financing, many people in retirement simply do not want new debt. That preference is real and it is not irrational. They have spent decades paying things off. The idea of a loan the week after the last paycheck lands goes against what they have been building toward. A complete plan accounts for both the math and the person.

Which is also part of why there is no clean universal answer here. The right choice depends on your current tax bracket, what the IRA is earning, your available cash flows, your rate outlook, and your own relationship with debt. Working through all of that, with someone who knows your full picture, is exactly what a good advisor is for.

The cost nobody talked about

There is an additional hit buried in this transaction that most people do not see until it arrives two years later.

Medicare sets premiums based on income, specifically your Modified Adjusted Gross Income from two years prior. When income crosses certain thresholds, surcharges called IRMAA, Income-Related Monthly Adjustment Amounts, get added to Part B and Part D premiums. For a married couple filing jointly in 2025, the first threshold kicks in at $212,000.

In the year they funded the renovation, the large withdrawal pushed their total income to roughly $233,000. They crossed the threshold. Two years later, they paid an additional $1,800 in Medicare Part B surcharges for that single year of elevated income.

It is not catastrophic. But it is also not nothing, and it is the kind of cost nobody brings up in the moment because the focus is on the renovation, not a Medicare bill that is 24 months away.

Add it to the tab: $40,519 in federal income tax, $1,800 in delayed Medicare surcharges. The renovation that cost $150,000 ended up closer to $192,000 all in.

One more thing they lost

In the year they pulled $150,000 for the project, they could not also do their Roth conversions without pushing into even higher brackets. They had started building the habit. They understood the strategy. The project cost them a year of progress on it, one fewer year of converting traditional dollars at the 12% rate, one fewer year of Roth compounding. The renovation did not just have a tax cost in the withdrawal year. It set back the work they were already doing.

It is also worth noting that this is one of the subtler advantages of the financing path, when the numbers support it: a HELOC keeps the conversion window open. Conversions and repayment can run at the same time. The renovation does not have to cost a year of progress.

What the efficient path looks like

The efficient path in this case does not require perfection. It just requires time.

The options that are unavailable today were available several years ago. Backdoor Roth contributions during high-earning years. Deliberate conversion work in the years leading up to retirement. A taxable account built alongside the traditional dollars they were already accumulating. None of it would have required dramatic changes to how they saved. Just a different direction for some of those dollars, pursued consistently, over time.

With enough of that time, the renovation is not a tax event. It is a withdrawal. Same income. Same house. Same $150,000 project. Federal tax: $0. IRMAA not triggered. Roth conversions continue uninterrupted that year. The project costs what it costs.

The difference between that outcome and the one they are navigating is not a smarter investment strategy. It is not a different savings rate. It is not a product they missed. It is years. Years during which the architecture could have been built gradually, one decision at a time, without urgency.

That is the thing about time in financial planning that tends to get underestimated. It is not just about compounding returns. It is about having options. Years of runway create choices. A few months of runway create constraints. The couple in this story is not in trouble. But they are navigating a decision that would have been straightforward had the architecture been a few years further along when it was needed.

The counter-argument worth addressing

Someone will read that last section and push back: Roth dollars should grow the longest. Spend everything else first and let the tax-free account compound. Do not touch it for a home project.

That is conventional wisdom for a reason. Roth money growing tax-free for decades is genuinely powerful, and the instinct to protect it is sound. But the argument contains a hidden assumption: that leaving Roth untouched is costless except for the forgone growth. In this specific situation, it is not.

First, the math is more balanced than it appears. Both accounts grow at the same rate. If they leave $150,000 in Roth and pull from traditional instead, the traditional dollars they did not touch keep compounding too. The real cost of using Roth is not the full future value of those dollars. It is only the tax differential, what they save by not paying $40,519 in federal income tax. That is the actual tradeoff, not the total compounding of the account.

Second, using Roth eliminates the IRMAA surcharge entirely. Roth withdrawals do not count toward MAGI for IRMAA purposes. Pulling from traditional did.

Third, they preserve their conversion year. The project and the strategy do not compete with each other.

The “never touch Roth” rule is a useful default when there is no particular reason to use it. This situation gives them a specific, quantifiable reason to use it. That is when a heuristic should yield to the analysis. The point is not “use Roth for home renovations.” The point is that having the choice was worth $40,519 in federal taxes, plus the Medicare hit, plus a year of conversion progress. They did not have the choice. That is the whole problem.

What this is actually about

The couple in this story is not in a bad position. They are in a constrained one. Every path available to them carried a cost that did not need to be there, not because of anything they did wrong, but because nobody ever showed them that the architecture would matter at this particular moment, on this particular decision.

The structure of where your money lives, across three fundamentally different types of accounts, determines how much flexibility you have when a real decision shows up. That is the framework worth building.

The three buckets

All investment accounts fall into one of three categories based on how your money is taxed on the way in, during growth, and on the way out.

Taxable accounts. Your standard brokerage account. You invest after-tax dollars, owe taxes on dividends as you receive them and on realized gains when you sell, and pay capital gains rates when you access the money. The upside is not tax efficiency. It is flexibility: no contribution limits, no withdrawal rules, no penalties for early access.

Tax-deferred accounts. Traditional 401(k), traditional IRA, SEP-IRA. Contributions go in pre-tax, reducing your taxable income today. The money grows without being taxed annually. Every dollar that comes out in retirement is ordinary income, taxed at whatever rate applies then. The key word is deferred, not eliminated.

Tax-free accounts. Roth 401(k), Roth IRA, HSA. Contributions come from after-tax dollars. Growth is tax-free. Qualified withdrawals are tax-free. Pay taxes once on the way in and the government is done with that money.

Why most high earners end up in one bucket

The couple in this story did not choose their architecture. It accumulated.

When you started your first real job, HR walked you through benefits during a hectic first week. You selected a contribution rate and landed on traditional because that is the default in most plans, and because “pre-tax” sounds right when you are just starting to earn real money. That one default established the pattern. Every dollar into the 401(k) built the tax-deferred balance. The Roth option, which requires an active decision, often goes untouched. The HSA, which we will spend all of next week on, typically gets used for copays rather than invested. The brokerage gets whatever is left.

The result is a financial picture heavily weighted toward one bucket. Not because anyone decided that was optimal.

The obvious objection: why not just use Roth?

If tax-free sounds obviously better than tax-deferred, you are paying attention. So why would anyone choose traditional? And why does taxable even make the list?

Why traditional still makes sense. The pre-tax deduction is rate arbitrage. If you are in the 32% bracket today and expect to draw down in the 22% bracket in retirement, traditional contributions save you 32 cents per dollar now and will cost 22 cents later. That is a 10-cent advantage on every dollar, compounding for decades. The math favors traditional when your current rate meaningfully exceeds your expected retirement rate. And because nobody knows what tax rates will look like in 30 years, holding both traditional and Roth is a hedge against that uncertainty.

Why taxable is not just the leftover bucket. At high income with real savings capacity, you will hit the contribution limits on tax-advantaged accounts. The 401(k) employee limit in 2025 is $23,500. The IRA limit is $7,000. If you are saving more than $30,500 a year, and many people at this income level are, the next dollar has to go somewhere. Taxable is where it goes. It also has genuine advantages: long-term capital gains rates are often significantly lower than ordinary income rates, tax-loss harvesting can offset gains elsewhere in the portfolio, and assets passed to heirs receive a step-up in cost basis that can eliminate capital gains taxes on a lifetime of growth. Taxable is not a consolation prize.

The real case for all three. No single bucket can do everything. Roth has contribution limits that prevent concentration even if you wanted it. Traditional makes sense when your current rate is meaningfully higher than your expected retirement rate. Taxable fills the overflow and provides flexibility the other two do not. Each piece does something the others cannot.

A diagnostic worth running

Add up everything: traditional 401(k) and IRA balances, Roth balances, taxable brokerage, HSA. What percentage is in each bucket?

If 80% or more of your accumulated wealth is in tax-deferred accounts, the architecture is worth examining. Not a crisis, just a question: is this the distribution you would choose deliberately, given how your income looks today and what you expect retirement to look like? Or is it what accumulated by default?

The follow-up depends on your specific situation, your income trajectory, tax picture, and time horizon. There is not one right answer. But the framework gives you a place to start.

Tactics are not strategies

If you have spent any time in financial media, you have run into these terms: backdoor Roth, Roth conversion, mega backdoor Roth. They get discussed as universally smart moves, things every high earner should be doing.

These are tools. They are not a strategy.

The strategy is the architecture, deciding what you want your account balances to look like across all three buckets over time and building toward it. Once you have that picture, the tactics fit in naturally.

The backdoor Roth lets you keep building the tax-free bucket when your income is above the limit for direct Roth IRA contributions. Not valuable in isolation. Valuable because it keeps one path open.

A Roth conversion moves money from tax-deferred to tax-free by paying income tax now instead of later. It makes the most sense in a lower-income year, a career transition, a sabbatical, the early years of retirement before Social Security kicks in, when you are filling a lower bracket at a favorable rate. In a high-income year, you are often just accelerating a tax bill you would prefer to defer.

The mega backdoor Roth is an after-tax contribution strategy available through some employer plans that allows additional money to flow into Roth accounts beyond the standard limits. Genuinely powerful for the right person in the right plan, but it requires that the plan allows in-service distributions or Roth conversions of after-tax contributions, which not all do.

Each is worth understanding. But advisors who lead with these tactics as their headline are showing you the hammer without the blueprint. We will come back to how all of this fits into multi-year planning in Week 9.

What’s next

Next week: the HSA. Of everything in the tax-free bucket, it is the most underused and least understood at this income level. I will share a personal story about why I did not use mine to pay for the birth of our son, and walk through why that made financial sense. It builds directly on the architecture we laid out today.

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Josh

Joshua Grass, CFA, CFP® is a financial advisor at Stapleton Asset Management. This blog is educational content and does not constitute personalized investment, tax, or financial planning advice. Tax figures referenced use 2025 brackets for illustrative purposes and 2026 IRS limits for active contribution and phaseout figures; consult a tax professional for advice specific to your situation.