A few days ago, I was chatting with Bryce Fathauer at SMI Advisory Services about Roth IRAs and Roth 401(k)s: Similar, Yet Different, an article in the March issue of the SMI newsletter. (The SMI newsletter and SMIAS are separate companies, but they share an affiliate relationship.)
Bryce mentioned a couple of Roth-related topics we didn't have room for in the newsletter article, so I thought I’d share them here.
First, he observed that Roth 401(k) accounts might seem like a boon to high earners because they lack income restrictions, unlike Roth IRAs. (Taxpayers who earn above a certain amount are not permitted to contribute to Roth IRAs.) However, he noted that the absence of an income limit for Roth 401(k)s has a tax downside.
"The IRS would love high earners to contribute to a Roth 401(k) since they [effectively] pay high tax rates on those after-tax contributions," Bryce noted. So even though high earners aren't restricted from contributing to a Roth 401(k), as they might be with a Roth IRA, they still need to consider the tax implications.
Bryce said that if current high earners can arrange to reduce their income during a period after their working years and before Social Security benefits begin, it may create an opportunity to make Roth conversions at potentially lower tax rates than they'd pay if making contributions to a Roth 401(k) now.
Inheriting a Roth account
On another Roth-related note, Bryce mentioned that one of the often-overlooked advantages of Roth accounts is that beneficiaries who inherit them don't have to take required minimum distributions.
In most cases, a non-spouse beneficiary of a Roth account must withdraw all funds within 10 years. However, the lack of RMDs allows the inherited money to grow tax-free for nearly a decade and remain tax-free upon withdrawal, provided at least five years have passed since the original owner opened the account.
Spouses who inherit and are the sole beneficiaries can simply treat the Roth account as their own or transfer the assets into their own Roth IRA.
Need help? Get help
Tax rules for Roths and other retirement accounts are sometimes complex and confusing. So, if you have any questions about rollovers, distributions, or inheritance, it's best to consult a tax professional before taking action. When it comes to taxes, it's always wise to check and double-check.
