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Pumping Money Into Roth IRAs: Now More Important Than Ever

By Jim Terwilliger

It is no secret that I like Roth IRAs…a lot. The Roth IRA is one of the most-beneficial gifts ever bestowed by Congress upon the American taxpayer.

Roth IRAs are funded with after-tax dollars. Most important, Roth IRAs are tax-free accounts. No income tax will ever be paid on the account’s income and appreciation, provided that certain conditions are met.

While the beneficial features of a Roth IRA have always made it an attractive retirement savings vehicle, the SECURE Act boosted its importance. As detailed in my recent column, the demise of the “stretch” IRA for most non-spouse beneficiaries makes inheriting a tax-free Roth IRA much more desirable than inheriting a pre-tax traditional IRA.

Yes, most non-spouse heirs must now empty traditional and Roth IRAs within 10 years following the year of the IRA owner’s death. But a non-spouse heir of a traditional IRA must pay income tax on all distributions over the 10-year timeframe. The heir of a Roth IRA can maintain the account in full force for 10 years, then empty the account completely tax-free on the final day.

A second, more-compelling factor is the high likelihood of increased future income tax rates. This will give each dollar in a Roth IRA even greater spending power than a dollar in a traditional IRA or 401(k).

So, what are the best ways to enhance a Roth IRA prior to or during early years of retirement?

Roth 401(k)/403(b) Plans

Several years ago, Congress allowed employers to offer an after-tax Roth version of their retirement plans to employees. Many companies have made that option available. Contributions are not capped by a high salary, and annual contribution limits are high. At retirement, these plans can be rolled over directly to Roth IRAs income-tax free.

Other workers may not have had this option or chose not to participate. However, some have had the option to contribute after-tax dollars to their Traditional 401(k) plans, resulting in a mix of pre-tax and after-tax money in these accounts. The IRS now allows the separation of the pre-tax and after-tax portions at rollover time such that the pre-tax portion can be rolled over into a traditional IRA and the after-tax portion into a Roth IRA.

Roth IRA Conversions

Conversions of funds from a traditional IRA into a Roth IRA are allowed at any age and without any income cap. If the traditional IRA consists entirely of pre-tax money, a conversion is fully taxable. For a mix of pre-tax (from deductible contributions) and after-tax (from non-deductible contributions) portions, only part of a conversion is taxable. Be aware of the pro-rata rule. The tax nature of all of one’s IRAs must be considered when determining the taxable portion of a conversion.

A few considerations:

• Conversions can be partial. For example, an ideal time for many early retirees to carry out a sequential series of partial annual conversions is between the start of retirement and age 70 (if deferring the start of Social Security benefits) or the age of 72 (when starting required minimum distributions). The strategy here is to limit conversions each year to stay within a lower tax bracket to minimize the tax impact of conversions.

• “Backdoor” Roth conversions work well for those who are still working and have no IRAs. The strategy is to open a “shell” IRA, annually make a non-deductible IRA contribution (the limit this year is $7,000 for those age 50 or older), then convert this contribution to a Roth IRA. If no other IRAs exist, each year’s conversion is non-taxable.

• This year presents a rare one-year opportunity for some retirees to carry out a Roth conversion at a lower-than-normal tax rate due to the elimination of 2020 required minimum distributions (RMDs), thanks to the CARES Act. Here the strategy is to convert enough to stay within a lower bracket before entering 2021 when we expect RMDs to resume.

Stripping Pre-Tax Portions from IRAs Prior to Conversion

This is a unique work-around to avoid the pro-rata rule for those who have IRAs with a mix of pre-tax and after-tax money and are still participating in an employer retirement plan. If the plan allows, it is permissible to roll over the pre-tax portion of an IRA into the plan, leaving only the after-tax portion. A subsequent Roth conversion will then be tax-free. This is also a way to set the stage for backdoor conversions for those who currently have IRAs containing pre-tax money.

The lesson here is that building Roth IRA balances is becoming increasingly important for estate-planning purposes and given the likelihood of higher income tax rates soon. The methods are many, depending on individual circumstances. Work with a trusted financial planner to develop your personal Roth strategy.

James Terwilliger, CFP®, is senior vice president, senior planning adviser at CNB Wealth Management, Canandaigua National Bank & Trust Company. He can be reached at 585-419-0670 ext. 50630 or by email at