Why Roth IRAs Are So Valuable (Maybe Now More Than Ever)

With Roth IRAs you’re able to direct after-tax savings to this investment account, where it’ll grow tax-free and can be withdrawn tax-free in retirement. Compare that to Traditional IRAs. With these, you save pre-tax dollars, the funds grow tax-deferred, but then you have to pay taxes on any funds withdrawn from those accounts during retirement.

Tax Benefits for Retirement:

Commonly people find themselves in a situation where they’ve done a great job saving for retirement, but most of their retirement savings are pre-tax and tied up in Traditional IRAs. So whenever they need to withdraw funds to sustain their lifestyle or to make a big purchase in retirement, it’s reported as taxable income and they have to pay taxes. For this reason, Roth IRAs can be an extremely valuable tool for retirement planning purposes. It allows you to diversify your retirement savings from a tax standpoint to give you greater flexibility when you need to make withdrawals from your accounts. 

Tax Benefits for Estate Planning:

In estate planning, aging investors generally want the ability to leave their retirement assets to their adult children, grandchildren, or nieces/nephews without creating an undue tax burden for that beneficiary. With Traditional IRAs, the beneficiaries (just like you) will pay taxes on any withdrawals made from these accounts. If we’re talking about a working adult, then any withdrawals will ultimately just increase their taxable income and add to their tax bill. For this reason, people with Inherited IRAs often leave the funds in the account and just take the Required Minimum Distribution (RMD) each year so as to limit the added tax burden. With Inherited Roth IRAs, you still have RMDs each year. However, all withdrawals are tax-free. So you don’t have to worry about paying taxes on those RMDs, and you have greater flexibility to withdraw additional funds from the account whenever you want. 

What Changed with the SECURE Act: 

Today, after the passing of the SECURE Act, the rules around non-spouses inheriting IRAs, Roth IRAs, or other retirement accounts have changed. Rather than being able to take the RMDs each year based on your own life expectancy and to stretch the distributions over your lifetime, most beneficiaries will have to distribute all funds in the account within a 10-year time period from when you inherited the account. For Inherited Traditional IRAs, this could create a significant tax burden for the beneficiary, especially if you’re a working adult with already high taxable income. For Inherited Roth IRAs, that 10-year rule still applies, but at least all distributions made over those 10 years will be completely tax-free to the beneficiary. 

So now, more than ever, it might be a good opportunity to evaluate whether Roth IRAs might fit into your financial plan from a tax or estate planning standpoint. Even if you find that you’re above the income limit for contributing to a Roth IRA, there might still be other options to consider (such as Roth conversions or Backdoor Roth IRAs).