Last week, I wrote about the reasons you should skip the Roth. The post was really meant for baby boomers, and I should have been clearer about that. Today’s post is specifically for baby boomers, who are finding themselves in a different situation than their younger counterparts. This difference has to do with when they will need to use their retirement dollars.
Remember, the Roth is a great tax-savings vehicle, but not on the front end — on the back end. In the Roth, you can individually put away $5,500 (add another $1,000 if you are over 50) per year, but you cannot deduct that amount off your income tax. The real benefit comes later, when you begin to pull money out of that account. None of the money will be subject to income tax. That’s right — you will not pay tax on any of the proceeds. Better yet, if your employer has a Roth 401(k), you can put away $18,000 (add $6,000 if you are over 50) each year.
And if you are really trying to use the Roth to your advantage, you can put away much more through a Roth conversion. This is where you take an individual retirement account or 401(k) balance and convert that to a Roth IRA. The catch is that all of the money you convert will be taxed in that tax year as ordinary income, so you can have a hefty tax bill. But this is one of the best ways to significantly take advantage of the benefits of the Roth.
Let’s go over the five reasons a boomer should have a Roth.
Your time horizon is long. The rule of thumb is 10 years or more, and the Roth makes sense. That way, the money has time to grow and accumulate the tax-free benefits.
I say your time horizon, but what I really mean is the money’s time horizon. In other words, even if you are in your 70s, 80s or 90s, a Roth could make sense. That’s because if the money will go to your kids or grandkids, they can still have the money grow tax-free over their lifetime. Note that they will have to take distributions (not taxable) based on their life expectancy, but they could have that Roth for decades. That is a lot of tax-free growth.
You have a lot of cash sitting on the sidelines. If this is so, it may be a good idea to deploy it in a Roth conversion. Over the last few years, I have seen more and more boomers with $50,000 or $100,000 or more sitting in cash. For most people, this is simply too much for an emergency fund. And cash is a nonperforming asset. Just having it sit in a checking account or money market account is a complete waste. In fact, it is losing money due to inflation. This money could be better spent paying the tax of a Roth conversion.
You have a lot of young beneficiaries. In this case, a Roth is a great estate-planning vehicle. Remember, the Roth will not impose a tax for any of the beneficiaries regardless of age. This simply means that the younger the beneficiary, the better the tax-free accumulation.
Taken a step further, as a parent or grandparent, you could even help your kids or grandkids open their own Roth. Those recipients must have earned income. But if you can help them with a little gift of a Roth contribution, they may be able to enjoy the tax-free accumulation benefits for years to come. Again, the younger, the better.
You have a good amount of after-tax contributions in your IRA. If so, it may be a good time to convert them to a Roth. Many of our clients have been contributing to IRAs for decades, even at a time when they could not deduct those contributions. Now may be the time to cash in on those old plans. You can convert your IRAs and will be able to get those after-tax contributions into the Roth without paying any tax.
While that sounds like a great idea, one thing to remember is that you cannot selectively choose which IRA contributions to covert. If you have an IRA where 50 percent of it was after tax, then you must convert the entire IRA to a Roth to be able to get the entire after-tax dollars in the Roth. This is the prorated conversion rule the IRS has put in place, which can make this type of conversion a little more difficult for some people, but it can definitely be beneficial.
You have contributed a significant amount of money to a 401(k). Sometimes 401(k)s even have after-tax contributions included in them. If this is the case for you, you can take those after-tax contributions and convert them directly to your Roth (this is only available in a corporate retirement plan). In this case, you do not have to worry about the prorated rules because the 401(k) company is required to keep the pretax and after-tax contributions separate.
There are definitely reasons to skip the Roth, but there are also reasons the Roth will make sense for boomers. It all depends on your particular situation.
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5 Reasons Boomers Should Consider a Roth originally appeared on usnews.com
