Originally published in Wealth Point, November 2018
With taxes at a historic low, now is a great time to consider a Roth IRA for your retirement planning. The greatest benefit of a Roth IRA for tax planning is that contributions are taxed up front, meaning tax-free growth and asset protection until retirement. A traditional IRA requires minimum withdrawals after age 70 1⁄2, but a Roth IRA lets you leave your funds to grow tax-deferred indefinitely, making it a great estate planning tool to pass on wealth to your heirs for lifelong tax-free income. You can also gain these many benefits by converting a traditional IRA with Roth IRA conversion.
If you haven’t considered a Roth IRA as part of your overall retirement planning, now may be a good time to evaluate opening a Roth IRA, or converting a traditional IRA into a Roth IRA as we approach year-end.
The greatest benefit of investing in a Roth IRA is being able to withdraw your funds tax-free during retirement. With a Roth IRA, you pay taxes on your contributions up front, giving your retirement savings the gift of tax-free growth.
A traditional IRA allows you to make tax-deferred investments, so that you pay taxes on any pre-tax monies at the time of withdrawal (usually after age 591⁄2). You’ll get hit with penalty taxes if you withdraw from a traditional IRA before age 591⁄2. With a Roth IRA, qualified withdrawals are tax-free (from both federal and state taxes generally) once you reach age 591⁄2, and you have had one Roth IRA open for over five years.
You can fund a Roth IRA through contributions or by converting a traditional IRA into a Roth IRA (more on this in #4). For 2018, Roth IRA contributions are $5,500 for individuals and $6,500 for those age 50 and older. For high-income earners in retirement, a Roth IRA can offer tax diversification and flexibility for dealing with unplanned situations where you might need access to cash, since Roth IRA distributions can be tax- free and penalty-free.
A traditional IRA has a lot of limitations once you hit age 701⁄2. For example, with traditional IRAs, once you reach age 701⁄2, you have to take required minimum distributions (RMDs). If you don’t take the RMDs or fail to take enough, you’re subject to a 50% excise tax on the amount that was not distributed as required. Also, you’re unable to make contributions to a traditional IRA once you reach age 701⁄2, so your ability to grow your assets in a traditional IRA is limited.
With a Roth IRA, you can leave your funds to grow tax-deferred for as long as you’d like. You can also continue to make contributions to your Roth IRA past age 701⁄2. According to the U.S. Census Bureau, the average length of retirement is about 18 years. Given that people are living longer, a Roth IRA can help you continue to grow your wealth, whether to fund your retirement lifestyle or to pass on your wealth to your loved ones. The one downside is that you can’t take any deductions for making Roth IRA contributions.
As mentioned, funds in a Roth IRA can grow tax-free and tax-deferred for a long time. This makes Roth IRAs a great vehicle for estate planning and passing on your wealth to your heirs, giving them tax-free income that can be stretched over their lifetime. Even though your beneficiaries will have to take RMDs after your passing, they will not be subject to income tax from Roth IRA distributions. This allows your beneficiaries to enjoy the benefits of having the assets grow tax- deferred, while not having to pay taxes on distributions they take.
You can open a Roth IRA by contributing post-taxed earned income or by converting a traditional IRA into a Roth IRA. However, there are contribution limits with Roth IRAs if you are a high-income earner. For 2018, if you’re single and your modified adjusted gross income exceeds $120,000 (or $189,000 of modified adjusted gross income if married), you won’t be able to make full contributions directly to a Roth IRA.
Another way you can still gain the benefits of a Roth IRA is through a Roth IRA conversion, where you take assets from a traditional IRA and roll it over into a Roth IRA. This conversion is treated as a taxable distribution (since you’re taking money out from a pre-taxed account), so it’s important to talk to your advisor and tax professional about how this event will impact your taxes before you decide to make the move.
A Roth IRA conversion may make the most sense if you think you will be paying the same or higher taxes in retirement. But with taxes currently at historic lows, it may be worthwhile to consider whether a Roth IRA conversion can help you avoid the potential of higher taxes in the future. One note of caution: For 2018 and beyond, you can’t reverse the conversion of a traditional IRA into a Roth IRA.
A fact that sometimes escapes from everyone’s retirement planning is that you have until the annual tax filing deadline to open or contribute to an IRA — so you can still make 2018 IRA contributions until April 15, 2019. When considering the annual contribution limit of $5,500 (or $6,500 if you are age 50+), this extra contribution can be advantageous. By using this extra contribution time, you can max out the previous year’s contribution while still being able to contribute in the current year.
Mercer Advisors is not a law firm and does not provide legal advice to clients. All estate planning document preparation and other legal advice is provided through its affiliation with Advanced Services Law Group, Inc.
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