The New Tax Law Makes Roth IRAs More Attractive: Part One

If you’ve been thinking about contributing or converting to a Roth IRA, this may be the time to do it. The recent overhaul of the federal tax code lowered the income tax rates for individuals – and lower income tax rates can help minimize the tax cost of contributing or converting to a Roth IRA.

Although the Tax Cuts and Jobs Act of 2017 did not set out to make Roth IRAs more attractive, that’s exactly what happened when the Act temporarily lowered the income tax rates for individuals. The lower tax rates are in effect through 2025, unless Congress acts to extend them. This gives you approximately a 7-year window of opportunity to contribute or convert to a Roth IRA at a lower tax cost.

Lower income tax rates are favorable for Roth IRAs because the money that you contribute or convert is taxed at ordinary income tax rates before it enters the Roth IRA. So lower tax rates generally mean you pay less tax on money you contribute or convert.

Once the upfront tax is paid, you will generally not owe any additional income tax on the money in your Roth IRA. All future growth and withdrawals in retirement are income-tax-free, provided you follow the rules for Roth IRAs.

In contrast, the money in a traditional IRA or other tax-deferred retirement account will be taxed as ordinary income when it is withdrawn at whatever income tax rates are in place at that time.

So when deciding between contributing to a Roth IRA or a traditional IRA, or converting from a traditional to a Roth, you need to consider whether you’d prefer to pay the tax now on your retirement savings at the current low tax rates or when you make withdrawals in retirement when rates may be higher, lower, or the same as they are now.

Contributing to a Roth IRA

Contributing directly to a Roth IRA has its limits. First, you or your spouse must have taxable compensation, such as wages, to contribute. Second, contributions are limited to a maximum of $5,500 for 2018, or $6,500 for individuals age 50 or older. And third, your income must be below certain limits to contribute. If your modified adjusted gross income is in the phase-out range shown below, the maximum amount you can contribute will be reduced. If it is greater than the phase-out range, you cannot contribute any amount.

If you are eligible to contribute, a Roth IRA can be a good choice, particularly for individuals who have decades to let their savings compound tax-free before they will need their money or who expect to be in a higher tax bracket in retirement.

If you are not eligible to contribute because your income is too high, see whether your employer’s retirement plan offers Roth accounts. If it does, you can contribute to one no matter how high you income.

Stay tuned for "Part 2" of our series covering the option of converting a traditional IRA to a Roth IRA.

Copper Leaf Financial is a fee-only, fiduciary firm and we can help you by providing advice on all financial matters. With offices in Williston and Rutland, Vermont, we develop a customized wealth management (financial) plan designed to integrate every aspect of your financial life. This is "true wealth management" - a holistic, all-encompassing approach that goes beyond just investment advice. Call us today at (802) 878-2731 to schedule a strategy session and begin building your road map to financial success.

Article published in Copper Leaf Financial publication Eye on Money - September 2018 issue.