Roth IRA and Roth 401k Accounts and Roth Estate Planning Strategies
There are trade-offs when deciding whether to allocate contributions to Roth retirement savings accounts versus traditional retirement savings accounts that have deferred income taxation features. In the majority of personal finance situations, making 100% of allowable contributions to Roth retirement plans would probably not yield the greatest total wealth in retirement compared to making contributions to traditional retirement savings accounts — even after income taxes on distributions from traditional retirement accounts during retirement are considered.
When the lifetime net present value of Roth contributions is compared to the lifetime value of making currently tax deductible contributions into traditional IRA and employer sponsored defined contribution retirement plans, such as 401k, 403b, KEOGH, and other plan accounts, most often traditional retirement accounts yield higher lifetime wealth net of taxes versus Roth accounts. Reducing current taxation with traditional accounts is usually a better bet than eliminating future taxation with Roth accounts.
However, a Roth retirement account contribution strategy also provides estate planning benefits that traditional tax-advantaged retirement accounts do not. Sometimes these estate planning benefits can tip the balance toward making Roth account contributions. When you expand your total present value analysis to include the long-term value to a multi-generational family, then Roth assets can have significantly greater value for some people.
If Roth assets remain at death, there are some generational tax avoidance advantages. In such circumstances where it is likely that a person’s assets will be adequate to cover retirement expenses even with a very long life, then it can be advantageous first to live off of traditional retirement plan assets, which are subject to mandatory withdrawals and associated income taxation in retirement anyway. This means that over one’s lifespan, when retirement assets are adequate for the long-term, then a larger and increasing proportion of one’s future financial asset portfolio would consist of Roth assets.
Why Roth retirement accounts can have some very significant advantages over traditional tax-advantaged retirement accounts for estate planning purposes
If a family’s financial model indicates that there is a strong possibility that they will still have tax-advantaged account assets at death, then those assets should be Roth tax-advantaged account assets, where feasible. Roth assets can be inherited by children, for example, and those inherited Roth assets can also grow tax-free for a ten year period. Withdrawals during these ten years do not trigger income taxation on any Roth account asset appreciation benefiting the heir. (Note that the tax rules changed for stretch inherited IRA accounts with the passage of the U.S. SECURE Act at the end of 2019. See Traditional and Roth retirement accounts and estate planning after the SECURE Act of 2019.)
Only when these withdrawn inherited Roth account assets have been reinvested into a taxable account AND those reinvested and now potentially taxable assets have later appreciated in that taxable account, would only this subsequent asset appreciation potentially be subject to either short-term capital gains taxes or to long-term capital gains taxes. Depending upon the tax-efficiency of subsequent investments within this taxable account, recognition of taxes on asset appreciation could be deferred for a very long time.
Therefore, if you are among the minority of US citizens who can reasonably expect to exit this life with substantial tax-advantaged account assets, then let them be Roth account assets, if possible. Inherited traditional tax-advantaged retirement accounts do not provide as valuable tax avoidance benefits as those provided by inherited Roth accounts.
When Roth assets are attractive in the long run, one needs to overcome the hesitation to make higher current income tax payments on Roth account contributions or traditional retirement account conversions to Roth accounts. You need to possess available cash to pay the taxes, and to have the confidence that your future asset accumulation will be substantial enough to justify paying more taxes now for even greater tax savings in the future on a net present value basis. And, your kids could be quite happy with what your leave behind for them in the form of inherited Roth accounts.
Roth retirement plan account rules fluctuate over time
Prior to 2010, total income restrictions limited Roth account contributions to those of low to moderate earned income. This changed in 2010 as all income restrictions on Roth account contributions and Roth account conversions were eliminated. Whether income limits on Roth account contributions will be re-instituted in the future is obviously unknowable currently. But in the interim, those who want to make Roth contributions and do Roth conversions have a potential opportunity to improve their long-term wealth.
You should use a capable retirement investment calculator to better understand the potential size of your projected Roth retirement nest egg assets in the future and the trade-offs between Roth and traditional account contributions. You should find out whether you could be one of the minority of the US taxpaying population that could amass significant enough retirement assets to have a preference of holding Roth retirement account assets rather than traditional retirement plan assets. Do not just guess, because too much money is involved in the decision.
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This retirement planning spreadsheet software fully automates Roth account versus traditional tax-advantaged account retirement planning calculator analysis capabilities. It provides integrated Roth IRA retirement calculator, 401k retirement calculator, and other retirement plan calculator projection capabilities that take into account your particular current and projected lifetime financial planning situation. You can use VeriPlan’s flexible retirement planning tools to evaluate the net lifetime value to your family of choosing any combination of allowable Roth and/or traditional retirement account contributions over your lifetime. These retirement tax calculator features are just a few parts of VeriPlan’s rich set of lifetime financial planning and retirement planning software capabilities.
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