Society of Certified Senior Advisors: Should You be Building Roth Assets?

How much you give to Uncle Sam plays a big role in retirement. Find out if you could benefit by adding to a ROTH account that grows free of tax.

It’s tempting to contribute to a traditional 401(k) or IRA every year to get the nice tax benefit that comes with it. It’s like you never made the money, and your deposit grows tax-free. But the government will want its share when you pull the money out, and you will have to start removing it at age 73 (or 75 for those born in 1960 or later) to satisfy the required minimum distribution (RMD).

One option is to fund a ROTH account. Although you won’t get a tax break upfront, your contribution and all of the money it generates, (assuming the gains have aged five years, or you are at least 59.5 years old,) will be tax-free as long as you live. If your spouse is your beneficiary, it’s tax free for him or her, too. Non-spouse heirs won’t have to pay tax, although they generally will have to take the money out of the ROTH by 10 years after your death.

How to Fund a ROTH

The government has recently made it easier to fatten up your ROTH account. Small business owners can now contribute to a ROTH through a SIMPLE or SEP IRA. Workplace plans can allow employer contributions to go to a ROTH. Catch-up contributions for those making more than $145,000 must now go into a ROTH account. You can contribute up to $7,000 in 2024 ($8,000 if you are 50 or above) to a ROTH, as long as your modified adjusted gross income (MAGI) is less than $146,000 for singles or between $230,000 and $240,000 if you are married and filing jointly.

ROTH Conversion Calculator

It’s a helpful exercise to run some numbers on your own to get some ballpark figures on how a ROTH conversion might affect your portfolio. Here’s a free conversion calculator that allows you to input several variables, including assumed interest and tax rates.

Convert 529 to Roth up to $35,000

Grandparents might not have heard of a big change that is now in place for 529 education savings plans. You may now be able to use leftover funds to help a child or grandchild get an early start on funding their retirement. Beginning this year, you can roll unused assets with a lifetime maximum of $35,000 into the beneficiary’s ROTH IRA without penalty. This is a brand new provision that you can read about in detail here.

Another way to move money out of a traditional IRA and into a ROTH IRA is by doing a conversion. There are no income limits, so big earners can take advantage of this method, coming in through the “back door” and inspiring the moniker “backdoor ROTH conversion”. You merely deposit money into your IRA and then move it to a ROTH account. You’ll have to pay taxes on the money, but you can convert as much, or as little, as you like. Finally, if your 401(k) plan permits automatic ROTH conversions, you can make after-tax contributions and have them automatically convert to Roth.

Who May Benefit from ROTH Funding

When you contribute or convert to a ROTH, you must pay taxes on the money that year. It could be to your advantage:

You want to leave money to your heirs. If you have plenty of assets outside the ROTH for retirement and want to leave more for your heirs, leaving them ROTH funds rather than assets in a traditional IRA will alleviate their tax burden.
You have a lot of money in tax-deferred accounts. Diversifying your accounts by tax treatment will potentially enable you to optimize tax bracket management during retirement. For instance, if you need money one year for a new car, you could take it out of your ROTH account while still drawing your normal IRA distribution without affecting taxable income.
You have a year when earnings drop. If earnings have sunk due to business costs, the loss of a bonus, or some other reason, you may be able to convert money in a relatively low tax bracket.
You expect to be in a higher tax bracket in the future. You may prefer to pay today’s rate if you think you’ll be in a higher one in the future.

Who Might Not Benefit from a ROTH Conversion

In spite of the many benefits available from a ROTH, there are situations where conversion (and the resultant income bump) may not be in your best interest:

If your income is low enough, you may be better off realizing long-term capital gains.
If you qualify for the Affordable Care Act health subsidies and are on a marketplace plan, a ROTH conversion will bump your income and potentially cause you to lose or reduce those subsidies.
If you are 63 or older, the income jump from a conversion may affect the cost of Medicare premiums in the future by putting you over IRMAA limits.
If you’re collecting Social Security with a low income, a conversion could put you over income limits and make more of your benefit taxable.
If you just opened a ROTH and need not only the contribution but the gains within five years, you may run afoul of ROTH requirements.
You plan to use a Qualified Charitable Distribution (QCD) to distribute excess assets from your IRA and lower your RMDs.
You must pay the conversion tax with IRA funds, possibly negating the benefit of the conversion. A better scenario is to pay the tax with cash on hand.
You’re in retirement or very close and need your IRA to cover living expenses. If the money won’t have long to grow after conversion, then it likely won’t benefit you to put it in a ROTH.
You will be moving to a state with no income tax. It could be wise to hold off making conversions until they can be made free of state tax.

You don’t have to make an all-or-nothing commitment to ROTH conversions. In fact, you can do many small conversions over a number of years to spread out the tax consequences. As always, it’s important to talk to your tax advisor and financial consultant to understand the implications before instituting ROTH conversions.

This article is not intended to be a substitute for professional financial advice from a qualified financial advisor.