(This article has been updated with 2019 income and contribution limits.)
Free? Everyone likes free. Add on “tax-free,” and it’s even better. The Roth accounts offer a fantastic way to accumulate money tax-free. New tax laws make Roth accounts look better than ever.
The Tax Cut & Jobs Act lowered marginal tax rates, but, those rates revert to higher levels in 2026. No one knows if this will happen or not. Right now, according to the law, it will. If it does, we may never see tax rates this low again. That means getting money into tax-free vehicles now can turn into a significant boost to your after-tax wealth later.
With the potential for higher tax rates in 2026 and beyond, funding accounts such as the Roth IRA and Designated 401(k) Roth accounts, where money grows tax-free and assuming you follow the rules, is tax-free upon withdrawal, is more important than ever. Because when you withdraw those funds, rates may be much higher than they are today. Higher future rates are particularly likely to hit retirees as they reach age 70.
Many retirees are caught off guard by higher taxes when, at age 70-½, their required minimum distributions (RMDs) begin. At that age, an IRS dictated formula tells you the minimum amount you must take out of retirement accounts — and, for most people, the entire required withdrawal counts as taxable income. This extra income on the tax return often pushes some of the retiree’s income into the next higher marginal tax rate, can make more of their Social Security taxable, and in many cases, may cause them to pay higher Medicare Part B premiums. RMDs can create a delayed tax-bomb. Add on higher rates when that bomb hits, and ouch, your take-home pay in retirement can take a big hit.
Many people retire in their late 50s or early 60s, years before RMDs begin, which creates a window of time where tax planning opportunities abound. Research by firms like Vanguard, Morningstar, and LifeYield, shows actively engaging in tax planning can boost your after-tax income in retirement by a meaningful amount.
With lower rates now, you can engage in tax arbitrage.
For example, suppose between the ages of 60 and 70, you convert a portion of your IRA to a Roth IRA, and only pay taxes at the 10% and 12% marginal rates. Later in retirement, after reaching age 70-½, without this strategy, you would pay taxes on those withdrawals at the 22% or 24% rate, or, if tax rates revert in 2026, at the even higher marginal rates of 25% and 28%. By using the Roth conversion strategy, you pay taxes at 12 cents on the dollar today, instead of 24 cents or more per dollar later. That’s an arbitrage opportunity you don’t want to miss.
Many people assume if they make too much money they can’t use a Roth account. However, you can convert traditional tax-deferred retirement accounts to Roth accounts regardless of your income level. And, many employers offer the ability to make Roth contributions to the 401(k), regardless of income.
As far as the income limitations, if your adjusted gross income in 2019 is less than $193,000 for joint filers/$122,000 for singles, than you can make an annual contribution to a Roth IRA of $6,000 if you’re under age 50, or $7,000 if you’re 50 or older. If you have a nonworking spouse, and you have earned income, you can even make a spousal Roth IRA contribution for your nonworking half. With smart planning, there is usually a way to get money into a Roth.
Those within 10 years of retirement aren’t the only ones who should take a fresh look at Roth IRAs.
Younger folks still in their accumulation years, should see if their employer-sponsored retirement plan allows for Roth contributions. Under the old tax rates, maybe it made sense to use traditional deductible 401(k) contributions. But under current rates, that decision needs to be re-evaluated. The Roth contributions, although not deductible, grow tax-free and may prove to be far more beneficial in your later years.
Roth IRAs are one of what I call the two superheroes of retirement accounts. Smart planning means finding ways to get money into these superhero vehicles to help supercharge your savings. With the new tax laws, a little planning now can mean thousands in tax savings later.