A smart use of any retirement savings you’ve set aside in Roth IRAs and/or Roth 401k accounts can help you reduce the income taxes you’ll pay during retirement and also boost your wealth for future needs and goals.
This post looks at three possible ways to strategically use your Roth accounts during your retirement to make the most of your retirement savings. First, let’s learn some basic rules you need to know to understand these strategies.
Basic Rules About Roth Accounts
Anyone can contribute to a Roth IRA, provided you meet the eligibility rules summarized later in this post. You can also contribute to a Roth account in the 401k plan at your employer, as long as your plan offers a Roth account.
Any contribution you make to a Roth IRA or 401k account must be made from earned income, either from a paycheck from your employer or from self-employment income. If you have no earned income, you’re not eligible to contribute to a Roth account.
Roth IRA and 401(k) contributions are subject to federal and state income taxes in the year you make the contribution. However, the money you withdraw from a Roth account in the form of contributions and investment earnings isn’t subject to income taxes because you’ve already paid taxes on your contributions.
This tax treatment is the opposite of the tax treatment that applies to pre-tax IRA and 401k contributions. Those contributions aren’t subject to income taxes when they’re made, but the contributions and investment earnings are subject to taxation when they’re withdrawn.
One planning advantage of Roth IRA accounts is that they’re not subject to the IRS required minimum distributions (RMD). Previously, Roth 401k accounts were subject to the RMD rules, but the SECURE 2.0 Act eliminates the RMD for Roth 401k accounts starting in 2024.
Starting this year, the RMD rules only apply to pre-tax IRAs and 401k accounts, and they require that you start making withdrawals from your IRA for the calendar year during which you attain age 73 (provided you reach age 72 in 2023 or later). The withdrawal amount from these accounts is added to your taxable income for the year. FYI: The RMD age increases again to age 75 in the year 2033.
Reducing Income Taxes
One reason to contribute to a Roth account is if you believe that income tax rates will be higher for you in retirement compared to today. For example, if the 2017 Tax Cuts and Jobs Act (TCJA) expires on December 31, 2025 and isn’t replaced, federal income tax rates will revert to previous, higher rates.
Even with the TCJA in place, many retirees are finding themselves in higher tax brackets in retirement compared to their working years, due to saving diligently and earning substantial investment returns.
Another way to use Roth accounts to reduce your income taxes is if you have both pre-tax and Roth IRA or 401k accounts. In this case, you can manage your taxable withdrawals each year to keep your total taxable income from spilling over into a higher tax bracket. If you need more money to live on, you can withdraw from your nontaxable Roth accounts.
You can use the same technique for staying below the thresholds for IRMAA surcharges on Medicare premiums.
Protecting Against Long-Term Care Expenses
If you’re worried about paying for potentially high long-term care expenses in your 80s and beyond, one strategy that can help would be to devote your Roth accounts to that purpose. You can let them grow until your mid to late 80s when you might need extra money to pay for long-term care expenses. Just a reminder: Because your Roth accounts aren’t subject to the RMD, you can let them grow undisturbed.
If you’re currently in your 60s or early 70s, these accounts will have a long investing horizon which could justify a high allocation to stocks to help these accounts grow over time.
Leaving A Legacy For Heirs
If you want to leave your Roth account as a legacy for your heirs, you can leave the money in those accounts invested until you pass away. Once again, you might have a long investing horizon that could justify a high allocation to stocks.
If your heirs are named as a beneficiary on your Roth accounts, the account won’t go through probate and they can receive that payment free of income taxes. However, they will owe any estate taxes that might be due on this inheritance.
You could also combine the second and third strategies by investing your Roth accounts until you need them to pay for long-term care expenses. Any money left after you pass away could then be paid as a legacy to your heirs.
One last thought: Another possible use for Roth IRAs is for parents to fund an IRA for their children. If this is something you want to look into, be sure to do your homework as there are considerations and rules for this options that are beyond the scope of this post.
More Rules
If you haven’t yet retired but want to build up your Roth accounts so you can take advantage of any of these strategies, here are some rules you might need to know:
- There are no minimum or maximum age limits for opening a Roth account. However, any contributions must be made from earned income.
- The most you can contribute during 2024 to a Roth IRA or a traditional IRA is $7,000 if you’re younger than 50 and $8,000 if you’re age 50 or older. You can divide your contributions between a Roth IRA and a traditional IRA, provided the total doesn’t exceed the limits noted above.
- You can only contribute to a Roth IRA up to the above noted limits if your modified adjusted gross income (MAGI) is $146,000 or below in 2024 for single taxpayers and $230,000 or below for married couples filing jointly. Once your income exceeds these limits, the limit reduces until your income reaches $161,000 for single taxpayers and $240,000 for married couples filing jointly. With income above these amounts, you can’t contribute to a Roth IRA.
- The Roth 401k contribution limit for 2024 is $23,000 for employee contributions and $69,000 total for both employee and employer contributions. You can also contribute an additional $7,500 if you’re age 50 or older. You can divide your contributions between a Roth 401k and pre-tax 401k, provided the total doesn’t exceed the established limit.
- There are no income limits that prevent you from contributing to a Roth 401k, although you can only apply your contribution rate to compensation up to $345,000 in 2024.
- You can contribute to both a Roth IRA and a Roth 401k account in a year, provided you comply with all the limits described above.
Please keep in mind that this post provides a brief overview only of the strategies and rules regarding Roth accounts. You’ll want to check with your tax accountant, financial adviser, or investment adviser before implementing any of these strategies, and to learn how the rules might apply specifically to you.
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