As a financial advisor, I have the benefit of seeing retirement from several different perspectives. After working with many clients that are in or nearing retirement, I have had the pleasure of seeing the planning strategies and tools that have had the most benefit for retirees. In my opinion, the Roth IRA is perhaps one of the most underutilized yet beneficial of all retirement planning strategies. Although there are many benefits to a Roth IRA, there are three benefits that I find to be most intriguing.
1. After Tax Income
The main difference between a Roth IRA and Traditional retirement accounts (IRAs, 401ks, 403bs) are when the participant pays taxes. With Traditional retirement accounts, the participant will receive a tax deduction when they make a contribution and then are taxed when they withdraw funds, typically during retirement. With Roth IRAs, the participant receives no tax deduction at the time of deposit but avoids taxes when they withdrawal the funds out of their account. This provides a source of tax free income for retirement. Essentially, if an investor makes a $5,000 contribution to a Roth IRA and over 30 years it grows to $50,000, the investor has had a tax free gain of $45,000. The downside of this tax free account is that the participant does not receive a deduction when they make an initial contribution. Although not receiving a deduction may be a hard pill to swallow during working years, there are several reasons one would want a tax free pool of money during retirement. A few reasons include rising tax rates, avoiding taxes on social security, large purchases, or to keep ones tax bracket below a certain level. By starting a Roth IRA in addition to traditional retirement accounts investors are tax diversifying their retirement savings.
2. Avoiding Required Minimum Distributions
Investors may or may not realize that once an individual reaches age 70.5, they must begin withdrawing money from most traditional retirement accounts at a rate which is determined by the IRS. This is an IRS rule known as required minimum distributions (RMDs). Intention of this rule is to get investors to withdraw funds from retirement accounts and pay taxes. Once taxes have been paid on these retirement funds, the IRS does not really care what taxpayers do with the money, they simply wish to tax these funds. The penalty for not taking a RMD is 50% of the required withdraw. For example, if an individual is supposed to take a $5,000 RMD and does not take the RMD, the penalty is $2,500. However, there is some comfort in the fact that Roth IRA’s do not require RMDs. Roth IRA owners can keep funds in their Roth IRA until the day they die if they wish which brings me to my next major benefit, the estate planning advantages of Roth IRAs.
3. Estate Planning Advantages
For transferring wealth from generation to generation, Roth IRAs are second only to life insurance in efficiency. The money in Roth IRAs passes directly to heirs’ tax free. This can provide liquidity at death if there are final expenses or estate taxes. Roth IRAs provide a significant advantage to heirs over traditional retirement accounts because traditional retirement accounts are 100% taxable to beneficiaries and require beneficiaries to begin taxable RMDs based on their life expectancy (this can be of particular concern if heirs are still working and in a high tax bracket). Under certain circumstances, spouses are exempt from this rule.
Roth IRAs have grown in popularity since 2010 when the income restriction on converting a Traditional IRA to a Roth IRA was lifted, however, Roth IRAs are still underutilized by investors and financial advisors despite the obvious benefits. Although anyone with a Traditional IRA can convert to a Roth IRA, that strategy may not be right for everyone. Investors should consult their financial advisor and tax professional before making decisions that may result in tax consequences.
This commentary on this website reflects the personal opinions, viewpoints and analyses of the Financial Strategies Group, Inc employees providing such comments, and should not be regarded as a description of advisory services provided by Financial Strategies Group, Inc or performance returns of any Financial Strategies Group, Inc Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Financial Strategies Group, Inc manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
This article is written by Brice Carter.