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4 Hidden Benefits of Roth IRAs

Christine Benz
Jeremy Glaser

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm joined today by Christine Benz. She is our director of personal finance. We're going to look at four lesser-known reasons that investors may want to prefer Roth IRAs.

Christine, thanks for joining me.

Christine Benz: Jeremy, it's great to be here.

Glaser: The benefits of Roth IRAs are pretty well-known. You put in aftertax dollars and those grow tax-free for your lifetime. But beyond that, there's some other attributes of the account that could be pretty attractive. What's one of the lesser-known features of these accounts?

Benz: It's well-known among people who are getting close to retirement. But one, perhaps, less well-known feature to people who are young accumulators is this idea of not having to take required distributions later in life. I hear so much from retirees where they are withdrawing most of their living expenses from traditional IRAs, which are subject to ordinary income tax, and they also represent the RMDs, required minimum distributions, represent a little bit of a loss of control over your tax picture that you had earlier on in retirement. So, being able to avoid required minimum distributions, which you are able to do with Roth IRAs, is a huge selling point in my opinion.

Glaser: The second is that there's a lot of flexibility here.

Benz: There is, and this is one of the main reasons why when I talk to young savers who aren't sure where to start saving, I often recommend a Roth IRA because you have so much flexibility in terms of those withdrawals. So, you can withdraw your contributions at any time and for any reason without any taxes or penalties. That's one reason why I recommend a Roth IRA as a good emergency fund vehicle. Even if you have the best of intentions and you plan to leave in the money in there until your retirement, you can save within the confines of a Roth IRA, presumably in something a little bit safer, and build up critical mass in safe assets before you start saving in long-term assets.

Glaser: If I go on to the IRS website, it's going to say that I have an income limit about who can contribute to a Roth IRA. But it might be a little bit less well-known that there is a way around that?

Benz: That's right. So, there are income limits on contributions to Roth IRAs. What there aren't income limits on are conversions from traditional IRA assets to Roth. And so, back in 2010, I believe, this idea of a backdoor Roth IRA contribution was born. And the basic idea is that you fund a traditional IRA, it's a nondeductible contribution, because if you earn too much to make a Roth IRA contribution, you automatically earn too much to deduct your contribution. But you make that nondeductible traditional IRA contribution and then you convert those assets to Roth assets. So, this strategy won't make sense in every situation. One profile who needs to be especially careful would be the person who has significant traditional IRA assets elsewhere apart from this little starter IRA that they are doing. So, get some tax help before embarking on a backdoor Roth IRA maneuver. But it is a way for high-income folks to get some money into an IRA and in particular into a Roth IRA.

Glaser: And Roths could be a good way to get more money into a tax-advantaged account as well?

Benz: I think this is something that's not discussed so much. But as you said, Jeremy, at the top, you are making contributions of money that has already been taxed and yet, these contribution limits are identical, whether you are doing a traditional or a Roth contribution. And so, in my mind, one of the virtues of the Roth is that if you are, say, a higher income person and you are in a position to make the full IRA contribution of $6,000 if you are under 50 or $7,000 if you are over 50, well, effectively you are putting that much more in from the get-go because you are putting in aftertax dollars.

Glaser: But the Roth isn't right for everybody?

Benz: It's not. That's a great point, Jeremy. There are profiles for whom a traditional IRA is going to be preferable. One of the key categories that I would point to would be the person who is a later career saver who thinks, well, I haven't really saved that much for retirement. It may be that my income tax bracket is higher than it will be when I'm pulling the money out in retirement. For people like that who can get a deduction on their IRA contribution, they may well be better doing the traditional deductible IRA contribution and skipping the Roth.

Glaser: Christine, thank you.

Benz: Thank you, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.