For years the pathway to whether to “Roth or not” has been navigated by addressing two basic questions: What was your modified adjusted income? And what were your expectations regarding the future tax circumstances for yourself or your beneficiaries?
If you met the income specifications and anticipated that your tax rate over time would either remain the same or shift higher than it is now, then it made sense to consider the Roth IRA; the appeal of tax-free distributions down the road was too compelling to ignore. The Roth IRA’s bonus feature of not requiring distributions after age 70 ½ (otherwise known as Required Minimum Distributions or RMDs) was considered to be pretty nifty, too. Traditional IRA owners are not privy to these two beneficial features.
What to Know
There are two items in President Obama’s 2015 fiscal budget proposal that, if enacted, would change the landscape for Roth IRA owners and beneficiaries going forward.
First, the budget proposal would subject all retirement accounts to RMDs—yes, even for Roth IRAs. This is a big deal for individuals who wish to take distributions from their Roth IRAs in their eighties or nineties. Frankly, their premise for using the Roth IRA in the first place was to maintain full control over how much—and when—income was taken from this resource.
And, second, most non-spousal beneficiaries of retirement accounts (including the Roth IRA) would be required to make full withdrawals from their inherited accounts by December 31 of the fifth anniversary year of the original owner’s death. This would essentially eliminate the “stretch IRA” option, which currently allows non-spousal beneficiaries to spread withdrawals from their inherited Roth IRAs over their lifetimes. Young beneficiaries have traditionally benefited the most from the stretch option because they have been allowed to set up distributions based upon their own life expectancies and also list additional beneficiaries for any untapped dollars in the Roth IRAs that remain at their own deaths.
What to Do
While it is uncertain whether or not President Obama’s budget proposal will gain approval in Congress, there are some practical implications that remain clearly in view:
- Don’t pump the brakes on your financial plan. Keep working your plan; don’t let present uncertainty stand in the way of what you are trying to accomplish in the long run. If you need a thought partner along the way, enlist the support of a CFP® professional who can help you develop a financial roadmap that makes sense for your personal needs.
- Diversify your savings buckets from a tax perspective. Distributions from a tax-deferred 401(k) account (generally treated as ordinary income) are taxed differently than qualified withdrawals from a Roth IRA (typically tax-free after 5 years and age 59 1/2 ); as such, create a menu of different types of savings buckets from which you can pick and choose for income as your tax needs evolve over time. So, yes, please give the Roth IRA and the Roth 401(k) (if your employer offers it) serious consideration. Ask your qualified tax professional for support each step of the way.
- Take the long view. It is impossible to know what your precise tax-bracket will be in 25 years. But if you convert to a Roth IRA now, think about how any hefty federal or state taxes may impact your financial circumstances (or your beneficiaries’ circumstances) further down the road.
If you would like to learn more about the Roth IRA and how it can support your financial interests, reach out to a CFP® professional in your area today.