Roth IRA Tax Break
The legislation that will allow people earning more than $100,000 to convert from a traditional IRA to a Roth is a huge tax break for high-income people. There are a few significant perks to having a Roth IRA:
- Tax-free income growth until perpetuity
- Not required to start pulling money out after age 70.5
- Money from Roth doesn’t count in determining whether Social Security benefits are taxable
- Isn’t included in estate, so Roth portion won’t result in inheritance taxes
- Can leave to heirs, which they can cash in immediately or draw on for the rest of their lives — tax-free
The only downside is you have to pay taxes when you first convert it to a Roth (similarly to how only after-tax income can be contributed to a Roth). This can be avoided by staggering the conversions/contributions or just waiting until you are in a lower tax bracket.
But think about it, the ramifications of this can be huge! High-income people can now open a traditional IRA, stuff it with money, then convert it into a Roth IRA. And then all investment returns from any investments that are generated by the Roth’s money is non-taxable forever. And if the Roth is transferred to heirs upon death, they can also draw on it tax-free forever! Basically it “boosts revenue now at the expense of future years”.
Learning about this I’ve decided to take this plan of action (if this is a bad idea, please tell me): My parents have some money in 401(k)s which they want to use later when they are retired and in a lower tax bracket to pay off a large chunk of their home mortgage. Now instead of doing that, they convert the 401(k)s to Roth IRAs and then pay taxes on the conversion. They would have to pay taxes anyways if they take distributions from the 401(k). They leave me the Roth IRAs so I can let it grow and draw down on it tax-free forever. In place of the Roth IRAs I would give them an equal amount of my after-tax cash savings to pay the mortgage. That way I get the benefit of growing investments tax-free while they can still pay off their home mortgage.
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