One Key Advantage of a Roth IRA

In looking at Wikipedia's 401(k) IRA matrix that compares the benefits of a traditional IRA, a Roth IRA, a 401k and a Roth 401k, the following stands out as a BIG advantage of the Roth IRA:

Forced Distributions: None. This is a huge advantage for Roth IRAs within estate planning.

They're right -- this is a gigantic advantage for a Roth IRA over all the other options. FYI, the others force distributions at 70½. But with a Roth you can let the money sit and grow forever -- like until you die. Then the money can be used to pay your estate taxes (if you have any -- hopefully you've planned to minimize those as well.)

That said, this huge advantage is most likely to benefit those with high net worths who have large estates. And a great way to get a large estate is to make lots of money. But here's the catch: the Roth IRA limits the income you can make and still have a Roth. The income limit details:

Based on MAGI (modified adjusted gross income); Single: full contrib up to $105k, partial contrib to $120k; Married: full contrib up to $167k, partial contrib to $177k; Can't contrib > annual taxable compensation

So if you make over $177k, you're hosed -- no Roth for you! That said, $177k is a fairly high income, so if you make $150k, you can still have a Roth and it's quite possible to build a sizeable nest egg (and use the Roth for estate planning purposes.) All I'm saying is that those making $500k aren't socking huge amounts away in a Roth to help with estate taxes.

Anyone out there using a Roth IRA primarily because there are no forced distributions?

Comments

[STRONGside]

No forced contributions was not my primary reason for investing in a Roth. In fact, I did not even realize that until you mentioned it here in the article. However, I am not counting on my Roth as my primary retirement vehicle (I have a 403(B) through work that I invest the majority of my retirement in. However, my Roth has a sizeable amount in it, and continues to grow so I know it will come in handy if I can leave it until the very end to exhaust last (if need be).

[Matt]

I think everyone should look at the Required Minimum Disrtibution (RMD) requirements for 401k/IRA roll overs.Fidelity and I think Vanguard have calculators and it is free. A good tool to have when trying to figure out how mych to have in a 401k/IRA and a Roth. When you reach 70 1/2 you are required to take a minimum distribution even if you do not need the money. So if you have a million dollar IRA you will be required to take out x even though you only need y.

[dcs]

It was a factor for me as well, although not the primary one. I have no children so estate planning is not a high priority. The reason no mandatory distributions was a factor was for income tax purposes. Here's why - I would obviously like to minimize taxes as much a possible by using taxable/mandatory distributions for day-to-day living expenses, and tax-free Roth distributions for big, oddball expenses (new car, major home repairs, maybe travel) without bumping into another tax bracket, or worse, into AMT range (I should be so lucky). Where the taxes come in is as long as it's in the Roth account, no taxes. If I had to take mandatory distributions, I could still just set it aside until an expense came up, but the return on those accounts would be taxable. And, as a practical pessimist, I assume the tax rates will be higher then.

[Jonathan]

Note: if you exceed the income limits to contribute to a Roth, you can contribute to a non-deductible traditional IRA and then convert it to a Roth. There are no income limits on the conversion any more. You can do his every year. An extra step and hassle, but probably worth it.

[Scott]

If you are lucky, your employer may consider offering a Roth 401(k) feature in your retirement plan. No income limits, and the same higher contribution limits as a "regular" 401(k) ($16,500 in 2011; $22,000 if at least age 50).

This is not as common as you'd think, though, because it makes the plan more complex (and thus more expensive for the employer) to operate. It also makes it more difficult to communicate due to having two different types of 401(k) contributions, as most people do not understand how to choose between the two and/or do not have an accountant or financial planner to ask.

[Everyday Tips]

It's funny because people who make more than the income limit are frustrated because they can't take out a Roth, but on the other hand, making 177k is pretty cool...

[jeffbone]

@Matt: Took a quick look at the IRS website re: Roth contributions. I didn't see anything about limits on Roth contributions other than the AGI limit and the $6000/year restriction. If someone was facing a required minimum distribution from an IRA or 401(k) and didn't need the money, is there any reason why that person couldn't take the distribution and then contribute it into a new Roth?

@Scott: My employer just started offering a Roth 401(k) option. I think I need to check into it, thanks for the reminder.

[Brent]

Is the $177k limit for married persons what BOTH spouses make combined or can each spouse make up to $177k AGI and still get contribute to a ROTH IRA?

[Holly]

@ Brent: I believe the 177K limit refers to the income of both spouses combined.

[Paul]

What happens if you contribute to the Roth IRA and you end up making over the 167k or 177k for the year? How is that addressed?

[Brent]

@Holly: Thanks for the response.

I wonder why they seem to penalize married couples since being single you can contribute up to $120k? Assuming a married couple split the $177k limit, that is only $88.5k each and much less than $120k.

Seems odd

[Sunil from The Extra Money Blog]

i have always liked the estate planning aspect of the roth - my only hope is that the tax free status remains when i get to the qualifying age. with the way things are going i wouldn't be surprised if the government changes their mind one morning and decides to tax money that has already been taxed . . . not to mention change the force deduction rules

[Matt]

@jeffbone
The last time I looked at this the RMD for 401k and IRA was more that what I would be thinking about using yearly. Somewhere in the 70K range.

The point is if you qualify for Roth IRA keep a portion of your retirement in a Roth becasue the RMD takes effect with an IRA and 401k at 70 1/2 where a Roth does not have this restriction. Know your RMD implications on your IRA and 401k.

[JB]

I can't wait to have rich people problems.

[Old Limey]

I have been making MRD distributions every year since I turned 70. One point that might need clarifying is that although the distributions are mandatory you don't have to sell anything if you just transfer the appropriate amount of assets from your IRA into yout taxable account. Of course, you do have to pay taxes on the assets transfered but it's still a great deal because your money has been growing, tax deferred, ever since you first added it to your IRA.

There's another benefit that isn't widely known that is an advantage for high income retirees like myself that would otherwise have to make quarterly tax payments to the State and Federal governments. If when you make your annual MRD before year end you have your investment company, in my case it's Fidelity, withold state and federal taxes when you make the transfer from your IRA to your Taxable account, the cash witholdings get treated as if the money was received by the State and Feds as if it arrived in 12 equal payments throughout the year. Bottom line - I don't have to go through all the hassle of making quarterly payments.

Also by the time you are retired if you are able to have your taxable account primarily in a municipal bond ladder your total taxes will be minimized and the largest contributor to your taxable income will be your MRD. If you don't want to have to sell any of your IRA assets to generate the cash needed for your year end tax witholdings you can use a very stable mutual fund to build up cash throughout the year so that you can sell whatever shares are needed to make your year end tax witholdings. The mutual fund I use for this purpose is SNGVX since its annual return since 1/1/2000 has been 5.31%, it has very low volatility and sure beats keeping cash in a money market fund that pays almost nothing right now.

[Steffen]

@Paul: You will have to take the excess money out of the account. You have until tax day to do so.

[MrAtoZ]

My accountant says that the IRS really has no good way to verify whether your Roth IRA contributions should be restricted by the MAGI limits, i.e. even if you are partially or fully capped out because of your income, your contributions to the Roth IRA aren't tracked by the government.

[Ginger]

Keep in mind that if you make over the limit, putting money in your 401k/403 can drop you below the limit. It is one trick I plan to use to keep me in the lowest tax bracket I can be in.

[Alan S]

Don't forget that if you have the option of a Roth 401(k) with your employer, you can rollover to a Roth IRA upon retirement to get then benefits of no RMDs!

[Nashville]

I will be retiring in 9 months and already have an appointment with my financial advisor to meet with him right after (when my gross income falls like the proverbial rock) to discuss moving funds from my 401(k) and independent IRA accounts into a Roth when I will be in a lower tax bracket and therefore pay lower taxes on the money that has been growing tax-free for 30 years (?, well for a long time). And then that same money can continue to grow "forever" without any forced MDA.

[Apex]

@MrAtoZ,

You really want to take your accountant's opinion on that versus an IRS auditor who uncovers Roth contributions during a high AGI year.

I am pretty confident that if that was discovered on an audit it would create a huge amount of digging into other contributions accompanied by large fines and penalties.

Your accountant's response will be a simple .... OOPS.

But as already pointed out this can easily be addressed by a traditional contribution and conversion. No reason to play Russian Roulette with the IRS.

[Jim]

MrAtoZ,

I'm pretty sure your account is mistaken or maybe you misunderstood them.

The trustee of an IRA is supposed to report contributions using form 5498. The trustee is the company that you have the IRA with like Vanguard, Fidelity, etc. So the IRA owner isn't reporting it but their IRA company is. Its simple for the IRS to match your tax returns with your stated income and the 5498's reported to see if you're contributing when you shouldn't.

http://www.irs.gov/pub/irs-pdf/f5498.pdf
http://www.irs.gov/pub/irs-pdf/i1099r.pdf
"You must report contributions to any IRA on Form 5498"

https://www.franklintempleton.com/retail/pages/generic_content/prog_serv/tax/forms/5498.jsf

"The information on Form 5498 is submitted to the IRS by the custodian of your individual retirement arrangement (IRA) to report contributions including rollover contributions, Roth IRA conversion amounts, recharacterized contributions and the fair market value of your account. Form 5498 is used for reporting contributions to traditional, SEP, SIMPLE and Roth IRAs."

I certainly hope your account wasn't suggesting that you should contribute to an IRA when you're not allowed with the hope you won't get caught. That would be awful advice for an accountant to give someone.

[Jim]

Matt asked : "If someone was facing a required minimum distribution from an IRA or 401(k) and didn't need the money, is there any reason why that person couldn't take the distribution and then contribute it into a new Roth?"

Technically you could do that but its not likely many people would be in a situation to do so. To contribute to a Roth IRA you have to have earned income (basically W2 wages from a job). TO have required minimum distributions you have to be over 70 years old. THere are not many people who are over 70 and required to make RMD's yet still working.

[Kathy F]

I get a form each year from Vanguard that tells me how much I contributed to my Roth IRA for the preceding tax year and I think this form says that the information is also reported to the IRS. I just file the form away- no need for me to report it on my tax forms since no taxation involved. But the IRS does have the ability to track this info if they want to.

I have the Roth because of the tax-free earnings. I max out my TSP account (401(k) for govt employees), then contribute max to Roth. My plans are to use the Roth account in retirement only if and when the TSP money gets exhausted. My retirement planning calculations show that this fund could be exhausted in my early 90s, using conservative assumptions (5% return). But I also will get a pension and SS.

But my Roth could serve as an emergency fund if I really needed it. I can take out my contributions. I can't rely on my TSP money for that(can only borrow from it). Hopefully I would never have to do an early withdrawal of Roth contributions. I am trying to beef up my savings account (actually held in rewards checking for 2.5% interest) so I would not have to do that.

If I did not have the tax deferred income from the TSP contributions, then I would be close to or over the income limit for allowing contributions to Roth.

I understand that when I retire and no longer work, I cannot make normal Roth contributions. But I might try and rollover some of the TSP money each year that I don't need for expenses and transfer that to my Roth as long as I don't go up into next tax bracket doing that.

[Money Reasons]

My work has a Roth 401k, but I just like the simplicity of a brokerage account Roth IRA. And besides, I already have one.

The no "forced distributions" is a great perk and I'm considering using it as a inheritance vehicle for my kids if someday I find that I don't need to use it...

[jeffbone]

@Jim: That was my question regarding Matt's comment about RMD's. You're correct, there's a bit of a "Catch-22" in that most folks who would be required to take an RMD wouldn't have any earned income, and someone still working at age 70 or beyond probably doesn't have enough assets to force an RMD (yes, I know there would be exceptions...). I suppose someone in the RMD situation could work at a side/part-time job just long enough each year to earn the income required to make the Roth contribution but that idea also seems to have a bit of circular reasoning associated with it...

[MBTN]

You can get around the income limit for Roth IRA contributions by contributing to a Traditional IRA and then converting it to a Roth IRA. As of 2010, there is no income limit for Roth IRA conversions.

[Davevanallen]

RMDs are only a big deal for people who are close to retirement. I'm not that close . . .the biggest advantages for me are (1) very low likelihood of taxation on gain and (2) ability to remove contributions at any time for any reason with no tax or penalty after 5 yr holding period, and gain can be removed for the education of youself, child or grandchild w/o tax or penalty.

The three biggest items on the federal budget are all entitlement programs (medicare, medicaid and social security) and ARE NOT GOING AWAY any time soon. Social security benefits might be delayed/taxed, traditional IRA monies will be taxed, but Roth IRA contribs *seem* more insulated from taxation.

529 educational accounts are abused/mis-sold by lots of sales reps. Even Coverdell contrib's are over-subscribed. Why open a college savings account if your Roth isn't fully funded yet (see point #2 above)

[Davevanallen]

p.s. Roth IRAs lock in their tax rate at a point in time where our tax bracket is relativey low. In the future, it will be much higher. Now it's 10-35% (http://www.statefarm.com/_pdf/2011guide.pdf), which is very low when compared to history (http://en.wikipedia.org/wiki/Income_tax_in_the_United_States#History_of_federal_income_tax).

[roth ira]

I'd rather use Roth IRA's for dividend stocks. It makes the dividends better knowing they won't be taxed. Plus a Roth IRA should be one of your conservative accounts when it comes to retirement. Save the risky picks to your active unlimited account. Roth IRA's are limited to $5000 a year which doesn't go far.