Roth management in retirement


Rebecca Katz: We have another question from Charles in Houston, Texas, who says, “In retirement, should my Roth be managed? Should I continue funding it in retirement, start withdrawing before or after taxable and tax-deferred accounts?” We promised to talk about managing retirement income using a Roth. Is there a good approach here? And if he’s retired, I assume he has no earned income and therefore can’t contribute?

Maria Bruno: So you can’t contribute unless you have earned income. If you’re taking distributions by having the different account types, you can strategically manage that on a year-by-year basis. So the previous individual who was in a low tax bracket, for instance, may be considering a conversion. Well, if you’re withdrawing and you may be in a very low tax bracket, then you typically would—for whatever reason in a particular year—then maybe you would want to draw from tax-deferred that year and not Roth.

Generally speaking, the more you can let the Roth grow tax-free, generally the better off— because that account gets to grow and you don’t necessarily need to take the RMDs and what-not. But assuming that you don’t have RMDs from the traditional IRA, you’re usually faced with the “where do I spend from” and generally if you have taxable assets—because those are taxed at lower rates, capital gains rates are taxed lower than income tax rates, and you might have some losses and things like that you can manage in taxable accounts—that’s usually the first source of spending. Beyond that, then you want to look at what your current tax rate is versus future tax rate expectations.

Joel Dickson: And tax rates can change quite a bit in retirement. I mean, think if you have large medical expenses one year. So you might have much higher itemized deductions, for example. Well, there your tax rate is a little bit lower than normally where it would be. And so there you might want to take distributions from the traditional IRA, because it won’t be as heavily taxed. Whereas in other years maybe you have a higher income, and so to the extent that you need resources from a retirement income standpoint, you take it from the Roth.

Alisa Shin: This is where I risk getting kicked under the table by my investment colleagues here. From an estate planner’s perspective, obviously depending upon what your overall taxable estate is, what your net worth is, if you are subject to federal or state estate tax—if you are, from an estate planner’s perspective, it is generally better to leave what I’ll call taxable assets, non-IRA assets, to your individual beneficiaries than it is to give a traditional IRA. Just because that IRA will be subject to both the state tax and income tax as your beneficiary takes it out, especially if your beneficiary will be in a higher tax bracket than you are currently in. It might be even more important for you to spend down from your traditional IRA.

Where I usually end up compromising with my colleagues here, which came about in 2010, was to say if you don’t want to spend down your traditional IRA, at least convert that amount into a Roth IRA and we get almost the best of both worlds.

Maria Bruno: I think what we’re really getting to here is that there’s an interplay between income taxes and estate taxes, depending upon how large your net worth is. And if you’re in that situation and you want to pass assets to your heirs or charities or whatnot, then you really probably want to sit down with a professional and talk about it. Because you do want to maximize the wealth transfer, minimize the current taxes as much as possible. But there is a big interplay between income taxes and estate taxes.

Joel Dickson: There’s just big interplays all over the place here. I actually worry we’ve given the impression that in the year of Roth conversion, you’re always going to have induced even higher taxes. Yes, you have to pay the tax on the conversion. We talked about deductions and exemptions and so forth. But even there, there are actually potential offsets, because if you have more income you might have less alternative minimum tax. So you might not be paying the full freight of the marginal income tax rate.

Or it might raise your charitable deduction cap. Because you have more AGI, adjusted gross income, you can actually give more to charity if you’re a big charitable giver in those years. So one strategy is actually to pair large charitable giving with Roth IRA conversions. So there are lots and lots of nuances to this.

Rebecca Katz: Sounds like you need both the estate planning attorney and a good accountant.

Important information

All investing is subject to risk, including the possible loss of the money you invest.

Withdrawals from a Roth IRA are tax free if you are over age 59½ and have held the account for at least five years; withdrawals taken prior to age 59½ or five years may be subject to ordinary income tax or a 10% federal penalty tax, or both.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

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