The ongoing discussion – "To ROTH or not to Roth"

For many workers (especially those who are self-employed) who don’t have access to a 401(k) plan at their employer, IRAs (Individual Retirement Arrangements) remain a viable way to save for retirement. Unlike the ease of payroll deduction in an employer offering retirement plan, however, those who meet their own payroll must show more discipline to get the funds from their “business checking account” into their own IRA accounts. . (I am very familiar with this challenge.)

Most people who have taxable income and are over the age of 18 can set up an IRA. Once someone decides to fund their own retirement account, they should talk (or research on their own) with an advisor about which type of IRA makes the most sense for them: traditional IRA or ROTH IRA.

Over the years, I have learned to simplify this “To ROTH or not to Roth” discussion with my clients and contacts by asking them a fairly simple question: “Do you want to pay tax on seed and get the crop tax free? OR “Do you want to get a tax deduction for the seed and worry about taxes on the crop in the future?”

Let me explain. With a ROTH IRA there is no current tax deduction, which means you would fund the account with after-tax dollars. With a Traditional IRA, you enjoy a current tax deduction, so there’s an immediate benefit during the year you fund the account. With a ROTH IRA, the money grows tax-free and when you withdraw it, it’s also tax-free. Plus, with ROTH IRAs, the IRS doesn’t require you to start withdrawing funds when you turn 70½. Finally, with a ROTH IRA, when you die, your heirs receive the funds tax-free.

With a traditional IRA, the tax savings you enjoy today are offset by the potential pain of paying taxes on the larger amount of money (assuming your investments grew over time), and the IRS will force you to start withdrawing the funds once who reaches 70 ½ – in other words, they want their tax dollars – and they will get them from you or your heirs. However, if you are in a high tax bracket today and assume that you will be in a low tax bracket when you withdraw the funds, then a traditional IRA may still make sense.

Here’s a no-brainer: If you can establish ROTH for your kids (or grandkids) when they turn 18 (if they’re working), this is a great way to start your adult life. Companies like Vanguard and Fidelity have good online platforms that you can use for these types of accounts. They have “target date funds” that can be a good “set it and forget it” way for them to start investing. For our children, we also provide a dollar-for-dollar match for any contributions they make to their ROTH accounts throughout the year.

Today, since I primarily work with clients who have saved lump sums of money throughout their working lives, I often have the discussion about transferring money from Traditional IRAs to ROTH IRAs, called a “Conversion.” . In summary, if an individual has non-retirement funds that they can spend to pay taxes on Traditional IRA funds that they do not plan to use for several years, a conversion to a ROTH IRA should be considered. By doing this, the IRA owner will pay the taxes owed today on the amount he converts and will never again have to worry (or his heirs) about paying taxes on the increasing amount of money converted. Also, when they turn 70½, the amount they converted won’t have to be counted when calculating the amount of withdrawals the IRS requires them to take (Required Minimum Distributions – RMDs) and pay taxes.

A few final notes: There are income restrictions when it comes to getting a tax deduction for a Traditional IRA. There are also income restrictions that will affect your ability to contribute to a ROTH IRA; These restrictions vary depending on how you file your taxes: single, married, etc. There are also some restrictions on withdrawing funds from a ROTH IRA, depending on whether you’re withdrawing earnings or your basis (the amount you contributed), and how old you are. Your tax advisor can advise you on these issues and/or there is plenty of information online that will explain these items.