7 Benefits of a Roth IRA

Key Points – 7 Benefits of a Roth IRA

Why Two of Our Managing Directors Claim to Be “Rothaholics”
How to Avoid Paying Additional Taxes with Roth IRAs
The Importance of Tax Diversification
Rules for Roth IRAs
How a Roth IRA Can Benefit Your Heirs
7 Minutes to Read | 23 Minutes to Watch

What Are Some Benefits of a Roth IRA?

As self-proclaimed Rothaholics, Bud Kasper, CFP®, AIF® and Dean Barber could talk to you for hours about benefits of a Roth IRA. Bud and Dean strongly believe that the Roth IRA is one of the best things ever written within the tax code, so they compiled a list of seven primary benefits of Roth IRAs to back up their reasoning. Who knows? Maybe after learning about these benefits of a Roth IRA, you’ll become a Rothaholic too.

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1. Capturing Tax-Free Growth

If you have great deal of your retirement savings in a traditional 401(k) or IRAs, Roth IRAs could make a lot of sense for you. When you contribute to a 401(k) or IRA, you’re not required to pay any taxes at that time. That’s because they’re tax-deferred assets. When you take money out of those accounts, you’ll be taxed on the distributions.

With Roth IRAs, though, contributions are made with after-tax dollars. But once you pay the taxes on the Roth contribution, all the earnings and distributions within the account grow tax-free.

The opportunity to capture tax-free growth is arguably the greatest benefit of a Roth IRA, as taxes can be one of the biggest wealth-eroding factors in retirement. There have been several people that we’ve worked with who were under the assumption that they would pay less in taxes in retirement. But oftentimes, those people have been unaware of Required Minimum Distributions and that up to 85% of their Social Security income can taxable. More on those two things momentarily.

Comparing Your Current Tax Bracket to Your Future Tax Bracket

Another thing that everyone needs to be aware of is that tax rates are scheduled to go up after 2025. That’s because parts of the Tax Cuts and Jobs Act are set to sunset after December 31, 2025, and revert to the higher rates of 2017.₁

For example, let’s say that you and your significant other have $250,000 in taxable income and plan to file your taxes jointly. For the 2023 and 2024 tax years, you and your partner would be toward the bottom of the 24% tax bracket. But if you had the same amount of taxable income in 2026, you would jump up into the new 33% bracket. Any money you have in a Roth account doesn’t count as taxable income, so staying in a lower tax bracket is a big benefit of a Roth IRA.

2. No RMDs

Let’s address those two benefits of a Roth IRA that we hinted at earlier before we go any further. We’ll start with Required Minimum Distributions. RMDs are the minimum amount that you’re required to take out of your retirement account or IRA each year.

Whether you’re still working or retired, RMDs are required to be taken from traditional IRAs, SEP IRAs, and SIMPLE IRAs. But not from Roth IRAs. Roth IRA owners can leave funds in the account indefinitely—all while capturing tax-free growth.

3. More of Your Social Security Won’t Become Taxable

The fear of running out of money in retirement is very real for many retirees. One of the most common reasons people run out of money in retirement is due to the early death of a spouse. We certainly hope that isn’t something that you (or your spouse) have to deal with, but it’s something that needs to be planned for. Part of that planning should include determining how to maximize your Social Security benefits.

Social Security by itself is a tax-free benefit, but it’s not realistic to get through retirement solely on your Social Security benefits. It’s an asset that becomes taxable when you reach certain income levels. Exceeding the taxable income thresholds of $25,000 (if you’re single) or $32,000 (if you’re married) could cause up to 50% of your benefit to become taxable.₂ And if you exceed $34,000 (single) or $44,000 (married) in taxable income, that’s when it jumps up to 85% of your benefit being taxable.

To make sure that you’re not exceeding those taxable income limits, you need to have a CFP® Professional and CPA that work together for you. At Modern Wealth, our CFP® Professionals and CPAs will calculate your provisional income, which is a formula takes 50% of your Social Security benefits and combines it with your gross income and tax-exempt interest. Notice that Roth IRAs don’t factor into provisional income. Income from a Roth IRA won’t make more of your Social Security taxable, which is no doubt a benefit of a Roth IRA.

4. Creating Tax Diversification

The focus of this article is on benefits of a Roth IRA, but there are some benefits to traditional IRAs. Obviously, one perk of traditional IRAs/401(k)s is not needing to pay any taxes on those funds until you begin withdrawing from the account. And if you’re charitably inclined and 70½ or older, you can donate up to $100,000 directly from a traditional IRA to a qualified charity for the 2023 tax year and it won’t appear on your tax return. This is known as a Qualified Charitable Distribution (QCD). That amount will increase to $105,000 a year for the 2024 tax year thanks to the SECURE Act 2.0.₃

However, hopefully what we’ve already shared has helped you understand some of the drawbacks from having most of your retirement savings in tax-deferred accounts. That’s why it’s so critical to have tax diversification by spreading your assets into taxable, tax-deferred, and tax-free accounts.

We’ve been doing a lot of Roth conversions for people in recent years as a tax savings opportunity if in fact tax rates do go up in 2026. A Roth conversion is a tax planning strategy in which you convert funds from a traditional IRA to a Roth IRA. You’re required to pay taxes on the conversion, but then all the earnings and distributions from the Roth IRA are tax-free. To learn more about the pros and cons of Roth conversions, download our Roth Conversion Case Studies white paper below.

Roth Conversion Case Studies

Keep in mind that in order to do a Roth conversion, you need to have enough funds in the tax-deferred and/or taxable buckets to pay the taxes on the conversion. Hence why tax diversification is key.

5. Penalty-and Tax-Free Withdrawals

If you’ve owned a Roth IRA account for a minimum of five years and are 59½ or older, you can make penalty-and tax-free withdrawals from the earnings of your Roth contributions. Earnings can still be withdrawn from your account prior to you turning 59½ or holding the account for five years, but understand they’ll be subject to a 10% penalty. They’ll also be taxed as ordinary income.

We also want to make sure that you’re aware of the Roth IRA income limits for 2024 to qualify for full or partial contributions.₄ If you’re married and filing jointly, your modified adjusted gross income must be lower than $230,000 to make a full contribution (and lower than $240,000 to qualify for a partial contribution). The thresholds are $146,000 and $161,000 for single filers. The contribution limit for Roth IRAs (and traditional IRAs) for 2024 is $7,000. That can go up to $8,000 for those who are 50 and older when taking advantage of a $1,000 catch-up contribution.

6. Utilizing a Backdoor Roth IRA

If you exceeded those Roth IRA income limits (or could in the future), there’s still an opportunity for you to get money into a Roth account. That opportunity exists in the form of a backdoor Roth IRA. To make sure we’re crystal clear, a backdoor IRA is a tax planning strategy, not a retirement account.

When utilizing a backdoor Roth IRA, you’ll be contributing funds to a traditional IRA that have previously been taxed. After making the non-deductible contribution to an IRA, you’ll do a Roth conversion. There aren’t income limits with Roth conversions like there are with traditional IRAs, so that’s the loophole that’s created with backdoor Roth IRAs. This benefit of a Roth IRA can be a very useful tax planning strategy for high income earners.

7. Building Generational Wealth

The last item of our list of Roth IRA benefits is a benefit to your beneficiaries. If you want to leave a lasting legacy to your loved ones, the tax-free inheritance that comes with inherited Roth IRAs can do exactly that. While your beneficiaries will be subject to RMDs with inherited Roth IRAs, the distributions they make will be tax-free as long as you’ve followed the Roth five-year rule. If building generational wealth is important to you, make sure that you’re aware of the benefits of a Roth IRA.

How to Become a Rothaholic

So, are you like Dean and Bud and want to become a Rothaholic after learning the benefits of a Roth IRA? If so, make sure to join our Rothaholic Club. To get the latest updates on Roth legislation and Roth-related planning opportunities, sign up for our Rothaholic Club here.

Do You Have Any Questions About the Benefits of a Roth IRA?

If the benefits of a Roth IRA that we’ve shared have you eager to get money into tax-free Roth accounts, we can help you determine how to do that in the most tax-efficient manner possible. Start a conversation with our team below so that we can learn more about your situation and if/how you can benefit from a Roth IRA.

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The reason we said “if/how” instead of “how” is that Roth IRAs aren’t for everyone. For instance, converting to a Roth IRA could put you in a higher Medicare bracket. Make sure that you’re weighing all benefits and drawbacks of Roth IRAs before contributing or converting to a Roth IRA. Our team of professionals—which includes CFP® Professionals, CPAs, CFAs, estate planning specialists, and risk management specialists—is ready to help you with that.

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Investment advisory services offered through Modern Wealth Management, LLC, an SEC Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.