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“Too many crooks spoil the Roth.” ― Brian Spellman
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It’s no secret I’m a fan of Roth Conversions, and. have been for many years (See: WEIGHING THE PROS AND CONS: ROTH IRA VERSUS TRADITIONAL IRA, and CONSIDERING A WITHDRAWAL: EVALUATING THE PROS AND CONS OF TAPPING INTO MY ROTH IRA.)
I finished my Roth conversions several years ago. I was pleased, and congratulated myself for my financial savvy! But now Older Me is telling Younger Me that maybe I was not as smart as I thought I was!
I’m now sitting on a pile of tax-free money that will remain tax-free for the rest of my life (if Roth rules and regulations don’t change.)
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What could be the downside of a pile of tax-free money? Let’s find out!
But first let’s outline the perceived benefits of Roth IRA accounts:
- Taxes are paid at the current tax rate– there are no worries about future tax rates and implications because taxes are paid based on current rates when conversions occur.
- Roth IRA contributions may be accessed without penalty– since contributions are made with after-tax dollars, contributions can be removed at any time without penalty.
- No RMDs– Unlike traditional IRAs, Roth IRAs don’t require that funds be removed at a certain age (Required Minimum Distributions.)
- Roth IRA distributions can play a big role in tax planning– because distributions are tax-free, Roth IRA accounts can be an integral component in tax reduction strategies.
- Money grows tax-free– both contributions and earnings grow tax-free inside Roth IRA accounts.
- Legacy benefits– Roth accounts can be transferred to heirs without income tax implications. Unlike Traditional IRAs, Roth accounts are normally transferred to heirs income tax-free.
- Helps to reduce or avoid Medicare surcharges– using qualified Roth distributions can provide tax-free money for living expenses. Avoiding the sale of taxable assets and Traditional IRA distributions reduces taxable income, and in many cases avoids Medicare IRMAA surcharges.
- Contributions can be made as long as a person continues to work– Roth contributions can be made regardless of age as long as a person has earned income.
All of the above statements are true, and outline the reasons I did Roth conversions in the first place. Imagine I’m now sitting across a table from you. I’m not some blogger giving some vague advice! This is 72-year-old me telling you directly what I’m feeling and what I’m experiencing psychologically. And, doing Roth conversions had me feeling great initially. Now, I’m not as certain the good feeling will last. Don’t get me wrong. I’m still glad I did the Roth conversions. But those conversions had unintended adverse consequences.
I’ve outlined the three unintended consequences below:
- Reluctance to access funds– probably the biggest downside and the hardest to overcome is the fact that I’m very reluctant to access Roth funds. Why? I’ve thought of several reasons to avoid distributing funds from my Roth account. *I went through a lot of trouble to get funds into my Roth account initially. It took multiple years of Roth contributions and Roth conversions to fund the account in the most tax-efficient manner. It was a lot of work and required a lot of planning. Why would I casually unwind all those years of work? *Contributions, conversions, and earnings all grow tax-free- The fact that almost no other vehicles are available that provide tax-free growth makes it difficult to remove any funds without feeling guilty. Consequently, I am always looking for other sources of retirement income instead of accessing my Roth IRA account. Removing dollars means I lose further tax-free compounding in the Roth account. *Taxes have already been paid, and funds will remain tax-free forever. *Most retirement planners agree that Roth funds should remain intact within the account as long as possible, and should be accessed last and after other assets are depleted.
- Saving for legacy bequests– Roth funds currently can be passed on to heirs tax-free. This is huge! Who wants to provide a legacy for their children that will create headaches and tax burdens? This is the case with Traditional IRA funds. Roth funds are distributed tax-free and can continue to grow tax-free for an additional ten years after the death of the original account holder (The ten-year rule.) Inherited Roth IRA accounts can remain open for up to ten years, but must be closed and all funds removed by the tenth anniversary of the initial account holder’s death. What an incredible gift! I can gift my children with a tax-free account, and can continue to grow tax-free for 10 additional years!
- No forced RMDs create reluctance to access funds and unnecessarily reduce spending– the third and probably the hardest resistor is the fact that I am not forced to take out any of the funds. If money remained in my Traditional IRA, I would be forced to begin taking RMDs next year at age 73. Because taxes have already been paid, and because of Roth IRA regulations, there is no forced distribution of money in a Roth account at any time. Forced distributions from a Traditional IRA would mean more dollars available to spend. I feel that having a Traditional IRA account would provide more spendable income due to the forced distributions.
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Final Thoughts
In our current financial environment where the vast majority of pre-retirees and recently retired are encouraged to convert all or most tax-advantaged Traditional IRAs and 401(k) accounts into Roth assets, people may want to pump the brakes once or twice to consider their long-term needs and wants. Financial advisors always tout the benefits of Roth conversions without considering the psychological effects of large Roth IRA accounts.
This whole dynamic of reluctance to spend Roth IRA dollars kind of caught me unaware. Older Me is questioning the wisdom of Younger Me.
I was always so focused on getting funds into my Roth account, that I never considered whether or not I would have second thoughts about distributing the tax-free dollars. But, I’m finding I’m reluctant to distribute these funds.
By way of explanation or disclaimer, I have other liquid assets and accounts that are adequate for my present needs. So, I’m fairly certain that I won’t need any Roth money soon. This makes me happy! If I need to access my Roth account years down the road, I’ll probably feel at that point that the Roth account has served its purpose well.
But, in retrospect, I probably should have left a bigger balance in pre-tax-sheltered accounts to nudge my spending. I guess it’s hard for anyone (me included) to feel sorry for me when the government is not able to force the distribution of my Roth account funds. The problem is I’m finding it hard to force myself to consider Roth distributions.
The good news is that my Roth conversions will save a great deal in tax payments that will be avoided starting next year. If my retirement accounts had remained in Traditional IRAs I would be faced with six-figure RMDs starting in 2025 and lasting for the rest of my life. Another big plus is that regardless of when I die, my Roth account can be transferred to my heirs with no income taxes due on the account.
Would I have done things differently? Everyone’s situation is different, but I would still follow the same path again. I might hold back a little more money in Traditional IRA accounts, but not a great deal more.
Now that I’m facing RMDs, I’m happy with my decision and strategy to convert the bulk of my retirement assets into a Roth account. I think that decision will be confirmed as I move into RMD age. Hopefully, Much Older Me will realize that Younger Me was correct, and Older Me was incorrect!
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