If you are under the age of 40, making Roth IRA or 401(k) contributions is a no brainer. Putting money into a Roth account that can grow tax free for the rest of your life is a fantastic benefit and the earlier you start contributing, the better. How if you are just a few years from retirement, or even in retirement, does making Roth contributions still make sense? The rule of thumb is that it doesn’t make sense to make Roth contributions if your tax bracket in retirement will be lower than your tax bracket while you are working. For most of us, when we retire we earn less, and therefore are in a lower tax bracket. In theory, this means making Roth contributions near retirement is not as advantageous. Still, I’m going to discuss some reasons why it still makes sense to make Roth contributions in your 50s and even 60s.
Roth IRA and Roth 401(k) Differences
The biggest misconception that people have is that Roth IRAs and 401(k)s are the same thing. Although they both essentially work the same way, contribution limits are much different. Roth IRA contribution limits are maxed out at $6,500 per year if over age 50. You, or your spouse, need to have earned income in order to make Roth IRA contributions but if you earn too much, you can’t contribute anything to a Roth IRA. If you are married and have an AGI over $189,000, or single and earn over $120,000 in 2018, then you are limited to how much you can contribute. Roth 401(k)s are a different animal, and if your employer offers a Roth 401(k), you can contribute up to $24,500 in 2018 to a Roth 401(k) if you are over the age of 50. Another misconception is that you are limited to $6,500 in your Roth 401(k), or that you can’t make both Roth IRA and 401(k) contributions, both of these are false. Now, let’s talk about the advantageous of making these Roth contributions, even as you approach retirement.
Your Tax Bracket May Not Be as Low as You Think in Retirement
One of the biggest benefits of a Roth IRA is there are no required minimum distributions (RMDs) at age 70 ½. Many retirees taxes go down significantly when they first retire, but many times taxes shoot up once RMDs start at age 70 ½. For example, someone who is 70 ½, and has a $1 million pre-tax IRA/401(k) account balance, will need to withdraw roughly $36,400 that first year. Add this income to social security and a potential pension, and taxes may not be as low as you anticipated. For many retirees, account values continue to grow throughout retirement and these RMDs will get larger and larger as you get older and therefore taxes will just go up. Limiting these RMDs through Roth contributions or conversions, can go a long way towards lowering your long-term tax liability.
Taxes are Low Right Now
The recent reduction in tax brackets has made Roth IRA/401(k) contributions very attractive. Starting in 2018, all tax brackets, besides the lowest 10% bracket, will be reduced by 2 to 4%. Unfortunately, unless these tax breaks are extended, these lower taxes will end starting in 2025. Your income may be lower in retirement, but still you could be in a higher tax bracket in retirement than where you are today when tax rates increase. Also, who knows where tax brackets will be in 20 or 30 years from now, it is possible that they will be much higher. Take advantage of these lower taxes now by making Roth contributions.
Plan to Leave a Legacy
I speak with many families that have a goal in retirement to spend every last dollar and leave nothing for the kids. Other families goal in retirement is to leave a lasting legacy through a large inheritance. If your goal is to leave a lasting legacy there is no better legacy planning tool than the Roth IRA. Roth IRAs have no RMDs and can grow tax free for both your life, as well as your children’s life. This tax free growth for a long period of time is a huge long term advantage. Your children, or whomever your beneficiaries, will be able to receive a large chunk of tax free money. Although your beneficiaries, outside of your spouse, will need to take distributions of the inherited Roth IRA, it will be smaller distributions spread over their life.
You are Eligible to Make Roth IRA Contributions but not Traditional IRA Contributions
If you are married and have an adjusted gross income (AGI) of over $121,000, you are not able to take a deduction for contributing to a traditional IRA. See the limits here. So, if you make over $121,000 but under $189,000, the Roth IRA limit, it makes sense to contribute to a Roth IRA. If you have a lot of money in a savings, checking, or brokerage account; move this money each year into a Roth IRA. This is a great way to shelter money from the tax man and start enjoying tax free growth.
Certainly the younger you are when you start making Roth IRA contributions the better, but you are never too old to make Roth contributions. Trust me, you will never be upset that you have tax free income in retirement.