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Highlights of this Newsletter:
Benefits of the Roth IRA
Traditional IRA vs Roth IRA
Tax considerations
Income Limits
Backdoor Roth IRA strategy
Cumulative Tax and RMD Impacts
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Benefits of the Roth IRA
Individual retirement accounts (IRAs) are tax‐advantaged vehicles designed for long‐term savings
and investment. The two most common retirement accounts designed for individual investors are
the Traditional IRA and the Roth IRA. These can be used independently or in conjunction with
retirement accounts that are available through your employer (such as a 401k or 403b). Both are
great vehicles for savings, and it’s never too soon to start planning and saving for retirement. The
decisions you make today, as we will see in the data and charts, can have a large impact on your
future.
With a Traditional IRA, you contribute pre‐tax dollars, your money grows tax‐deferred, and
withdrawals are taxed as current income after age 59 ½. With a Roth IRA, you contribute after‐tax
dollars, your money grows tax free, and you can make tax- and penalty-free withdrawals after age
59 ½.
There are some tax considerations to think about before making contributions to a Roth IRA, so
consult your financial advisor or CPA before making the decision. One consideration when
choosing a Roth over a Traditional IRA is your taxable income and the current tax benefit you
might receive from a Traditional IRA. The other is income limits. For the 2022 tax year, a single filer
earning over $144,000 cannot contribute directly to a Roth IRA due to the income limits placed by
the IRS. The limit for a married couple filing jointly is $214,000.
There is a current loophole that can enable higher income earners to contribute to a Roth IRA.
This strategy is called the “Backdoor Roth IRA.” It allows investors to contribute to a Traditional
non‐deductible IRA and immediately convert it to a Roth IRA. Roth conversions are typically
taxable, but if you only convert the contribution—with no associated gains—there is no taxable
event. It is important that any other retirement assets are consolidated in your qualified
employer-sponsored plan or some of the conversion may be taxed. This strategy is being
threatened by the Build Back Better Act and has been targeted by lawmakers over the past several
years.
In the graphs below, we review a scenario for a 25‐year‐old (Mabel) making maximum
contributions to a Traditional and a Roth IRA annually until age 72, which is the current required
minimum distribution (RMD) age. Current law allows Mabel to contribute $6,000 annually, with a
catch‐up provision to contribute a total of $7,000 annually when she turns 50. We assume a 6%
annual rate of return and a 30% tax rate on withdrawals at age 72. Her total contributions over
the 47‐year period are $304,000.
When Mabel retires at age 72, the value of both her Traditional and Roth IRA will have grown to
$1,674,146. At age 72, she will be required to take out 3.65% (1/27.4) of her IRA based on the
current uniform lifetime table provided by the IRS. This 27.4 factor declines over time, thus
increasing the percentage of funds required for withdrawal. For instance, at age 80, the factor is
20.2, meaning Mabel is required to take out 4.95% (1/20.2) of the value of her account. When she
turns 90, the factor is 12.2, meaning the required withdrawal is 8.19%.
So at age 72, Mabel is required to take $57,642 from the Traditional IRA, but she is not required to
take any funds from her Roth IRA (under current law). She will then have to pay $17,293 in taxes
(30% tax rate) on her Traditional IRA withdrawal. In the graphs, taxes are not deducted from the
value of the IRA portfolio, but you can see the impact of the required minimum distributions (and
tax burden of the distributions).
Eventually the value of the Traditional IRA starts to decline because the amount required for
withdrawal begins to exceed the growth rate of 6%. The value of the Roth IRA continues to grow
since no distributions are required. By age 90, the value of Mabel’s Roth IRA is $3.1M higher than
the value of the Traditional IRA.
The graph below shows the annual RMD (blue bars), the tax impact (orange bars), and the combined impact (grey line). The 19 distributions from age 72 through age 90 total $1.8M, resulting in $543,250 paid in taxes.
So which vehicle is right for you? Both are great places to save for retirement while providing tax benefits. These charts do not show the current tax savings you receive for a Traditional IRA (assuming you can make deductible IRA contributions under the income limits). Combined with company-sponsored retirement plans, you can boost your retirement savings.