To Roth or Not to Roth...That is The Question

Christopher Brown - October 24th, 2018

A question we are often asked, should I use a Roth IRA or Traditional IRA, a Roth Retirement Plan or a Traditional Retirement Plan. So here is my insight on the great debate.

Regular individual retirement accounts provide a tax deduction when contributions are made. When the funds are withdrawn, at some point in the future, taxes are due. There are some exceptions, such as a first house, 72(t) elections or hardship. Otherwise withdrawals from regular deferred accounts are subject to a 10% penalty, if withdrawn before age 59 and ½.

The funds must generally begin to be withdrawn at age 70 and ½, these are called Required Minimum Distributions or RMDs. After 59 and 1/2 there is no penalty, but taxes are still due. There are penalties if minimum withdrawals, RMDs, are not made, and these are so onerous that no one with good planning ever misses a minimum withdrawal.

Tax deferral means that contributions create a tax break when money is contributed to the retirement account. Investment earnings are untaxed so long as the investments remain in the account. When funds are withdrawn from the account ordinary income tax is due on the amount of withdrawal.

Roth accounts work in similar ways except that contributions are not tax deductible when contributed. Funds still grow tax deferred, but when the funds are withdrawn at normal retirement age, there is no tax due. Additionally, for the owner of the Roth account there are no required minimum distributions.

So the Roth question revolves around a taxes now or taxes later sort of evaluation on a case by case basis determined by the fact set. Most people have higher earnings while they are working. Retirement income from savings, Social Security, inheritance, and other sources fail to surpass earnings during the working years for most people.

Though there is a segment of the population who will make more money in retirement than they did in their working years. Some people will sell a business, inherit a large sum of money, win the lottery, or have some other windfall that drastically increases their net worth and consequently their income.

Families with estate tax issues sometimes benefit from Roth conversion planning to consider lessening overall tax burdens for heirs. These are complicated situations and conversions may not be worth the expense or risk for smaller accounts.

Evaluations should be done based on each family’s fact set. The right answer to Regular versus Roth depends on your individual situation.

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