To Roth or Not to Roth; That Is the Question

June 6, 2018

One very important tax-law change to pay attention to this year is the rule change that applies to Roth IRAs. This year, the income limitation goes away, so almost everyone can take advantage of the Roth IRA. And, for this year only, if a conversion is done from a traditional IRA to a Roth IRA, an investor can pay the taxes over two years, instead of just one. This tax-planning opportunity could mean lower taxes in the future.

Let’s review the differences between a Roth IRA and a traditional IRA.

Normally, when contributions are put into a retirement account, like a traditional IRA or 401(k), the money is pre-tax and grows tax-deferred. It saves the person money in taxes today, but they will pay taxes in the future when a withdrawal is made, usually in retirement. The Roth IRA contributions, on the other hand, are after-tax money and grow tax-free. All withdrawals, including profits, are not taxable under the current tax rules as long as the account has been opened at least five years and the investor is over the age 59 ½.

The first question to ask is if taxes will be higher or lower in the future. We think taxes will be higher under future presidents. For one, the government has spent so much money that taxes are likely to go up. Currently, our tax rates are still some of the lowest in history.

Second, the old concept of retirement accounts was to save money on taxes while you are working. Then, in retirement, you will have less income and be in a lower tax bracket. For most people we meet with, retiring with a lower standard of living doesn’t sound great. Instead, they want to be successful in their investing and saving and have a retirement that allows them to enjoy the fruits of their labor.

The old concept just doesn’t make a lot of sense for many families, and the Roth is a great concept to consider. A Roth IRA usually benefits long-term, successful investors who feel taxes will be higher in the future.

Since investors are no longer allowed to undo the Roth conversion, and the stock market is at record highs, you might want to consider using accounts that are conservative or protected against stock market losses. If your primary goal is to protect your spouse or leave as much money as possible to children or charities, a life insurance plan could be a better option.

I know — life insurance? Yuck!

However, life insurance can be a way to leverage dollars to get more benefits and still be a significant part of a comprehensive investment plan. We conclude that Roth IRA accounts can still be great, and, under the new tax rates, an investor might be able to pay less in taxes than before on the conversion; but know your options and have a detailed analysis before you make the final decision to convert your account.