By David Brooks, Founder & President of Retire SMART
I am glad that the Roth IRA and Roth 401(k) are common knowledge in the general public and are increasingly used to reduce taxes. Nearly 90% of employers offer a Roth 401(k). Only in the last decade have I found this to be true. When I started as a financial advisor, the Roth option was virtually unheard of by the general public and was generally unused by financial advisors as a strategy.
Part of the reason the Roth was slow to catch on in the financial world was the prevalence of two major misconceptions that caused financial advisors and their clients to dismiss Roth accounts.
Anybody Can Have One
Conventional wisdom said people no longer earning or with too much income were not eligible for a Roth account. That changed in 2010. There no longer are limits for Roth conversions. There are ways for people in both categories to utilize the Roth option.
At Retire SMART, we are bullish on the Roth conversion. We have helped numerous clients understand the tax advantages of Roth Conversions and strategically assisted clients with transferring assets from various types of accounts into Roth accounts.
Retire SMART has copyrighted the term Strategic Roth Integration, the name of our conversion process. SRI is descriptive because it is a strategy for keeping more of our clients’ dollars in their own hands rather than Uncle Sam’s. It also allows us to turn the tables on our least-favorite federal agency by reversing the letters IRS.
Take Tax Hit Now
That leads us to the other major misconception about Roth accounts: the tax implications.
Conventional wisdom says defer, defer, defer when it comes to taxes. Put that money in a traditional IRA or 401(k) and put off paying taxes on it.
Once again, conventional wisdom is wrong – most of the time. In rare cases, a Roth account is not the best option. More typical is the client who, thanks to a Roth account, has more money in his pocket because he took care of his tax liability while tax rates were lower and his pile of assets was smaller.
The 2017 tax cuts expire in 2026. There is talk of the tax cuts being extended, but what about 10 or 20 years from now?
Then, look at the annual deficits of the last few years and the dramatic increase in the overall debt. In round numbers, the debt was $10 trillion when Barack Obama became president in 2009, $20 trillion when Donald Trump became president in 2017, and $28 trillion when Joe Biden became president in 2021. It’s now $36 trillion. Eventually, we have to pay for this explosion of spending.
According to the Wharton School of Business at the University of Pennsylvania, the federal government can restore fiscal sanity and balance the budget by 1) cutting spending by 30%, 2) raising taxes by 40%, or 3) devising some combination of those two options. Which is more likely to happen: a significant decrease in spending or a significant increase in taxes?
As fiduciaries, we at Retire SMART must act in our clients’ best interest. My professional judgment as a financial planner and my common-sense judgment as a citizen tell me that taxes are going up sometime in the near future. And they’re not likely to come back down, at least not within the lifetimes of our clients.
Uncle Sam offers you the tax-deferred option because, in the long run, he knows he will collect more money from you that way – with your larger accounts taxed at higher rates – than if you pay the taxes upfront. For most clients, it is better to take the tax hit now on conversions to a Roth account rather than being taxed much more in 10 or 20 years when they withdraw funds from non-Roth accounts.
Settle with your Uncle now; then watch that Roth account grow, and relish the prospect of withdrawing funds from it whenever you want in whatever amount you want and doing it free of taxes.
