8 Advanced Reasons to Roth or Not: RMDs, Inheritance, and Social Security Strategy
The Roth IRA. It’s often touted as the ultimate retirement savings vehicle, offering tax-free growth and tax-free withdrawals in retirement. But is it always the best choice? The answer, as with most financial matters, is a resounding “it depends.”
While the basic advantages of a Roth IRA are well-known, the decision to contribute versus opting for a traditional IRA or 401(k) gets more nuanced when you consider factors like Required Minimum Distributions (RMDs), inheritance, and even your Social Security claiming strategy. This article delves into eight advanced reasons to consider when deciding whether to Roth or not.
Before we dive in, remember this crucial point: Taxes are complex, and this information is for educational purposes only. Consult with a qualified tax professional or financial advisor for personalized guidance.
Here are eight advanced considerations that can sway your Roth or Not decision:
1. RMD Planning (Or Lack Thereof):
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Pro-Roth: Unlike traditional IRAs and 401(k)s, Roth IRAs are not subject to RMDs during your lifetime. This offers significant flexibility in retirement. You can strategically draw down other accounts first, allowing your Roth to continue growing tax-free for potentially decades. This is especially beneficial if you anticipate having substantial assets and want to minimize taxable income in later years.
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Con-Roth: If you anticipate needing all available retirement income, the RMDs from a traditional IRA might not be an issue. Moreover, the tax advantages of a Roth are only realized if your tax rate in retirement is higher than your current tax rate. If you anticipate being in a lower tax bracket in retirement, paying taxes now on Roth contributions might not be advantageous.
2. Inheritance Implications:
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Pro-Roth: Heirs inheriting a Roth IRA benefit from tax-free growth and distributions (if held for at least five years). This can be a significant advantage, especially if your beneficiaries are in high tax brackets. The inherited Roth IRA, however, is not entirely without tax implications. “Beneficiary RMDs” apply based on the heir’s life expectancy, meaning they must withdraw funds over a set period.
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Con-Roth: While the inherited Roth offers tax-free withdrawals, the beneficiary RMD requirement means they must access the funds. This might be less desirable than leaving a taxable account that the heirs can manage entirely according to their own needs and timeframe, potentially allowing for strategic tax planning within their own portfolio. Also, keep in mind that the inherited Roth IRA may push the heir into a higher tax bracket if they have other income.
3. Tax Diversification Strategy:
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Pro-Roth: Having a mix of taxable, tax-deferred, and tax-free accounts offers incredible flexibility in retirement. You can strategically draw down different account types to manage your tax bracket and potentially reduce your overall tax liability. The Roth acts as a valuable tool in this diversification strategy.
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Con-Roth: If you’re solely focused on maximizing pre-tax deductions and believe you’ll be in a significantly lower tax bracket in retirement, focusing primarily on traditional accounts might be the better strategy. The benefits of tax diversification are only realized if you actively manage your portfolio with tax considerations in mind.
4. Medicare Premium Management:
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Pro-Roth: Your Modified Adjusted Gross Income (MAGI) directly impacts your Medicare Part B and Part D premiums. Drawing primarily from Roth accounts in retirement can help keep your MAGI lower, potentially reducing your Medicare costs.
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Con-Roth: This benefit only applies if your traditional IRA withdrawals are substantial enough to push you into a higher Medicare premium bracket. If your retirement income is relatively low, this might not be a significant factor.
5. Social Security Claiming Strategy:
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Pro-Roth: Social Security benefits can be partially taxable. Drawing strategically from Roth accounts can help minimize your taxable income, potentially reducing the amount of Social Security subject to taxation.
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Con-Roth: This strategy is most effective when combined with careful planning of other income sources. If your Social Security benefits are already below the taxable threshold, or you’re managing other income sources effectively, the Roth’s impact on Social Security taxation might be minimal.
6. State Income Tax Considerations (Both Now and in Retirement):
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Pro-Roth: If you live in a state with high income taxes now, and you plan to retire in a state with no income tax, contributing to a Roth now can be a smart move. You pay taxes now in the high-tax state, and then enjoy tax-free withdrawals in your low-tax retirement state.
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Con-Roth: Conversely, if you live in a state with no income tax now, and you plan to retire in a state with high income taxes, contributing to a traditional IRA and deferring taxes until retirement might be more beneficial.
7. Potential for Future Tax Law Changes:
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Pro-Roth: In an environment of potential tax increases, locking in tax-free withdrawals now might be a prudent move, especially if you believe tax rates will be significantly higher in the future. This offers a hedge against future tax uncertainty.
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Con-Roth: Tax laws are constantly in flux. It’s impossible to predict with certainty what future tax rates will be. The potential for tax law changes should be factored into your decision, but it shouldn’t be the sole determining factor.
8. Personal Risk Tolerance and Investment Horizon:
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Pro-Roth: Because you’ve already paid taxes on Roth contributions, you might feel more comfortable taking on slightly more risk within your Roth IRA, potentially leading to higher long-term growth. This is particularly relevant for younger investors with a long time horizon.
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Con-Roth: Regardless of the account type, your asset allocation should be aligned with your risk tolerance and time horizon. Don’t feel pressured to take on undue risk simply because you’ve paid taxes upfront. A well-diversified portfolio is crucial for long-term success, regardless of whether it’s held in a Roth or traditional account.
Conclusion:
The Roth IRA can be a powerful retirement savings tool, offering significant tax advantages and flexibility. However, the decision to Roth or not requires careful consideration of your individual circumstances, including your current and projected tax bracket, inheritance goals, Medicare premiums, Social Security claiming strategy, state tax considerations, and personal risk tolerance.
By understanding these advanced considerations, you can make a more informed decision about whether the Roth IRA is the right choice for you, helping you build a more secure and tax-efficient retirement. Remember to consult with a qualified financial advisor and tax professional to personalize this strategy based on your unique situation. Don’t blindly follow the “Roth is always better” mantra; instead, make a data-driven decision that aligns with your overall financial goals.
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Great video! But you missed one more reason to ROTH. If you are fortunate enough to have an estate that is flirting with estate taxes, then converting to ROTH could keep you out of estate taxes while preserving purchasing power.
Your xl sheet on social security income tax is really helpful but I am not sure it accurately figures out the capital gains portion of the income and its 'tax free or not' status in the lower marginal tax brackets. Please clarify that when you can and update the sheet for capital gains calc on how to not exceed the 0% tax bracket on it while also not dragging more social security into taxation zone. Thanks for all your are doing.
I would suggest and request calling out reasons and strategies for age-gap couples in every episode almost because I have found that there is a lot to decide and plan for when one of us becomes a single filer again in life eventually and everything about what would have been a good idea sort of changes with that eventual big life change. Thank you, Zach.
Thanks for all the informative content you provide, Zacc. I would love to see a case study of a couple in their mid 50s who have at least $3M in their tax deferred account, mortgage free, and not too concerned about living behind a legacy as a priority. Is it still worth doing a Roth conversion?
If you are 60 today your first RMD is 15 years away. Even a $5m IRA will only have a $200k year 1 RMD which added to SS will be in the bottom of the 24% tax bracket after inflation adjustments, with an effective tax rate under 20%. If I converted $200k per year to Roth for 10 years I would pay 36% in taxes and costs and would still have $3m and be in the 22% bracket with similar effective rate. Yes IRMAA surcharges will be higher by deferring but won’t start until age 77 (2 year look back) and to avoid IRMAA at 77 I would need to pay it for the 10 years I am converting making the break even age 87.
On your previous video item 4 bracket management, I assume you are referring to the benefit of withdrawals from the Roth later in retirement during SS and RMDs to meet spending needs and reduce taxable income. I am actually deferring to manage my future bracket. Today I am at the top of the 12% with the majority of income cap gains and dividends in the zero tax bracket. Including tax free bonds my MAGI is $150k. If I convert $100k to Roth (which would not make a dent) I will pay 36% in taxes and costs including fed and state tax, IRMAA surcharges, cap gains taxed at 15% instead of zero and phase out of the new $12k (joint) senior deduction. Any conversion over $100k adds the 3.8% NIIT, all to get money to a Roth I will never need in my lifetime. My heirs are in the 22% tax bracket (not expecting to change) and if retired will be in 10% or 12%.
For 20-30 year olds that usually end up somewhere in the 22% bracket, should we be contributing half roth and half traditional for maximum freedom? I can contribute a big chunk but am not maxing both the IRA and 401k.
We retired early from investing in the market. Converting will wipe out the health insurance subsidies. We have saved over $200k and counting in healthcare costs. Converting will affect Medicare costs. Converting 1 million dollars will result in about $200k in taxes. Had you not converted that 200k invested for 20 years becomes over $900k dollars. RMDS on 1 million dollars is less than 50k per year. Look at the Irmaa chart not very much money compared to the income. When I was self employed I paid over $2200 a month for my wife and I to have health insurance. We will be making more money in retirement and IRMAA isn't close to that in the highest bracket!!
RMDS can be offset by SWPs something else your fa will not talk about. Heirs can spread out the withdrawals over 10 years allowing the account to double more than covering the taxes. Just a 1% financial advisor fee on 1 million dollars for 20 years is over $530k dollars. A couple making 100k with 60k from Social security and 40k from IRA will have a federal tax of about $6,580.
The best strategy is to learn how to invest smarter. Making more money is the Real Key!!
We have done the math and are not converting our IRAs. Our IRA and Brokerage accounts double every 5-7 years we aren't worried about taxes!
Love the video! Would be interested how the numbers play out when you max out your 401k with a high company contribution rate. Can you save to much in a traditonal because the account could be so large in 35 years that it automatically puts you into a large tax bracket.
Lost ACA subsidy IS a major effect, especially when you fall off the subsidy cliff – much bigger than shifting income tax brackets.
First time here. 35 yo single male, looking to buy house, ROTH 401(k) contributor since I started in ‘18/‘19. Previously really income (graphic design) and now somewhat low-medium earner. Sticking with ROTH for life since I’ll never be able to max it.
Possible widow tax and dealing with RMD's in our older years is enough reason for us to convert. Wish we never opened these (403 & IRA)…What a lie we were told about being in lower tax brackets….gonna use the valley of opportunity for sure!
Had another potential reason to convert – albeit may not apply to a lot of people and relies on market conditions. People who have substantial cash reserves and substantial 401k balances may benefit from doing a Roth conversion when the market crashes (like when Trump first announced tariffs). This drops the 401k balance in the taxable account, you transfer what you can assuming you will pay the taxes with your cash reserves and then let the market rebound cause the Roth non taxable balance to benefit from the growth. In a way this can be looked at like one of the roundabout ways of moving free cash into a tax protected account. You can also theoretically not convert and invest the extra cash into the market but that will just result in taxable gains for as long as the money is invested.