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Roth IRAs Celebrate 20 Years

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Traverse City Record Eagle

Experts say it takes approximately 60 days to secure a new habit. It’s amazing, then, that despite its introduction in 1998, how long it has taken for the Roth IRA to catch on. Since its appearance 20 years ago, the retirement plan universe has been opened to the Roth investment option for many who also have a qualified plan. The primary benefits for those who qualify are tax-free growth as the investment performs (hopefully) and taxfree withdrawals with some shorter-term limitations regardless of the growth you’ve experienced over the years. No other investment affords all the benefits inherent in the Roth IRA, 401(k), 403(b) or 457 plans.


Are there other investments that could afford such a benefit? Well, yes and no – some investments have a few of the components of the Roth, but none in the exacting range the Roth IRA and Roth retirement accounts offer. The various ways to open a Roth can range from investing in a Roth IRA as you would a Traditional IRA (given that you pass the income limitation and have earned income), contributing through your retirement plan at work, converting a Traditional IRA or inherited retirement account as a non-spouse beneficiary or, lastly, through inheritance.


What are the major benefits? First, a variety of investments allowed in any Traditional IRA are also allowed in the Roth. This could include things like CDs, mutual funds, ETFs and annuities. The account, while not deductible for contributions, grows tax-free and does not require you take required minimumdistributions (RMDs) starting at age 70ó as does the Traditional IRA. This may be the best way to accumulate dollars for your later use as well. A spouse will receive the same benefit as you, assuming he or she is the primary beneficiary. Many of my clients believe they can’t have a Roth IRA because their accountant once advised against it since they were already investing in a 401(k) account at work. For many in that situation previously, the rules have been relaxed.


Let’s briefly cover the ways in which you might begin or add to a Roth IRA or Roth retirement account. First, there are no income limits on conversions from a Traditional IRA to a Roth. But watch your tax bracket to gauge the cost. Second, there are no income limitations for those contributing to a Roth 401(k). Monthly contributions you add to the 401(k) account can be added as a percentage to the Roth option if available in your 401(k). Most with earned income with some limitations can also add to or open a Roth IRA. There is no age limitation on adding dollars to your Roth IRA, unlike a Traditional IRA, which limits you to the max age of 70.


Virtually everyone can have or will have access to the Roth. Children inheriting the account from you must take RMDs based on their age, but they are tax-free to them. That is incredible given the growth potential. How much would children have to take assuming they inherit the account from you as parent? Based on an age of 50, the amount required would be about three percent. Theoretically, then, a child inheriting his or her parents’ IRA (per a $100,000 value) of any type would be required to withdraw about $3,000 in the first year, slowly increasing in percentage after inheriting an IRA or other tax-qualified account. If they’re taking tax free dollars, I’m sure they will love you the more for it.


We often counsel clients to think longer term if possible. Most of us underestimate our life expectancy by significant degrees. For whom does the Roth make the most sense? If you believe your tax rate may be higher in successive years, your income somewhat similar, and you have a life expectancy of about eight to 10 years and an ability to pay any tax due on a conversion.


As to life expectancy, at age 60 it will range on average about 23 to 25 years. When have you been comfortable being average? As in most situations, consider yourself well above average. The benefits then accrue much more to your advantage and loved ones as well.


How can you get a Roth account? Various types are discussed below. Please review these with a trusted advisor or other professional counsel to ensure that the plan you get is appropriate for your situation:

Investigate the 401(k), 403(b) or 457 plan at your place of employment. If available, consider placing a portion of your monthly investment into the Roth option within. Note: Most plans allow you to place whatever percentage of your contribution into the Roth. The beauty of this option is that, as you age, you can adjust that percentage. If access is not available, or you’d like to invest more than what the above accounts allow, you may qualify for a Roth IRA. If you have earned income within limits, $189,000 is the beginning of the phase-out, full phase out at $199,000 for married couples, and phase-out for single filers is at $120,000.
For additional potentially tax-free future income, consider converting a portion of your traditional IRA to a Roth. The cost of doing so depends on your tax bracket. Why might you consider this option? If you believe your tax bracket may be higher in the future, if you have the funds set aside to pay the tax due on conversion, and if your investment period is eight to 10 years to recoup the tax on conversion, this may make sense for you. Keep in mind that any amount you choose can be converted, but the new tax law does not allow you to change your mind once the conversion has been made.
The last option to add new money to the Roth is what’s called the “back-door” Roth or non-deductible IRA. This allows you to open an IRA regardless of income and then convert that account to the Roth immediately. The “why” for all of these is essentially freedom in the future from the onus of wondering how taxes might affect your income when you most want to draw it to fund your independence!


Dennis Prout is an Investment Adviser Representative with Capital Asset Advisory Services, LLC, a registered investment adviser. This information is strictly educational and taken from sources we believe to be reliable. It should not be used as investment or tax advice.