Tax Planning and Roth Opportunities: Some Key Considerations

Published 04/07/2021

By Marie Stark, CPA


The Roth was introduced more than 20 years ago as the new and improved individual retirement account (IRA) option. While there was much hype, and many were quick to fully embrace the concept, others remained cautious of the Roth IRA. The idea of paying taxes any sooner than necessary was not palatable to some, but the passage of the SECURE Act in December 2019 had many in the field taking a second look.


The following describes opportunities and situations where it would be advantageous to contribute and convert to a Roth:

Understanding Roth IRAs and Roth Opportunities

A Roth IRA is funded with after-tax dollars that allows qualified withdrawals on a tax-free basis provided certain conditions are satisfied. The contributory Roth can consist of both regular and spousal contributions and is the most straightforward way to participate. An individual may fund a Roth IRA on behalf of their married partner who earns little or no income. Spousal IRA contributions are subject to the same rules and limits as regular Roth IRA contributions and must be held separately from the Roth IRA of the individual making the contribution.


The maximum Roth IRA contribution for 2020 and 2021 is $6,000 plus a $1,000 catch-up contribution for individuals 50 and older. The ability to contribute to a Roth IRA is phased out for those whose income is above certain limits and extremely limited for those filing married filing separately.


Many employer plans (401(k), 403(b) and 457(b)) now include options for employees to elect Roth as an alternative to traditional contributions. Employees can contribute via payroll deduction thereby avoiding the income and filing status limitations. Aggregate employee elective contributions are limited to $19,500 in 2020 and 2021, plus an additional $6,500 for employees age 50 and over. Withdrawals of contributions and earnings are not taxed provided it is a qualified distribution. Unlike contributory Roths, distributions from a Roth 401(k) must begin no later than age 72 (or age 70½ if reached before January 1, 2020), unless the individual is still working and not a 5% owner of the sponsoring company.


The backdoor Roth provides an opportunity for those over the income limitations to take advantage of the Roth IRA. The individual first makes a nondeductible traditional IRA contribution and then immediately converts to a Roth. Since there was no deduction for the original contribution, there is no tax due upon conversion. Taxpayers must beware of the pro rata and aggregation rules when contemplating a backdoor Roth. If you have other traditional pretax IRAs (SEP, SIMPLE, rollover and contributory traditional IRAs), your basis is calculated as a percentage of total IRA assets. In addition, the aggregation rule forces you to include all IRA accounts. It is not enough to just keep the after-tax (nondeductible) funds in a separate account. For example, if you have $693,000 in a rollover IRA consisting of all pretax funds and perform a backdoor Roth transaction for $7,000, your basis in the transaction will only be $70 ($7,000/$700,000=1.00% after tax) and you will be taxed on the remaining $6,930.


If you find yourself in this situation, you do have some options.

·        Qualified Charitable Distributions: At age 70½, you can transfer up to $100,000 from your IRA directly to a qualified charity. The $100,000 maximum must be reduced by any contributions to IRAs made between age 70½ and age 72.

·        Qualified Health Savings Account (HSA) Funding Distribution: You can transfer from your IRA directly to your HSA tax free, but the transfer cannot exceed the maximum annual HSA contribution. In addition, you are only allowed to do this once in your lifetime.

·        Rollover to a Qualified Plan: Accounts that are part of a qualified plan fall outside of the pro rata and aggregation rules. Many employers allow rollovers into their qualified plans, although you should be mindful of current plan rules and if they will apply to your rollover (such as, in service withdrawals, investment choices, etc.). Individual 401(k) or Solo(k) is also a qualified plan in the eyes of the IRS and can be a great option for individuals with self-employment income.


Decision Points on Whether to Convert to a Roth

You have likely heard the saying, “Just because you can, does not mean you should.” This is particularly true with Roth IRAs. There are many things to consider when opting for a Roth.


You can convert all or a portion of your traditional IRA accounts and there is no annual limit as to how much you can convert. There is no early withdrawal penalty on the converted funds, but you must pay income taxes on the amount converted.


A popular strategy is to employ “bracket topping” where you convert enough to go to the edge of your tax bracket. Taxpayers with flexible income can time their income to maximize the amount they are able to convert without spilling into the next tax bracket.


For years, tax and financial advisors have been encouraging clients to take advantage of Roth IRAs by converting their traditional IRAs but this does not make sense for everyone. The broad assumption that you will be in a higher tax bracket in future years may not be true, and you cannot forget to consider the impact of state taxes. Even if you are not planning to retire in a no-income-tax state, many states have attractive retiree income exclusions. For example, Georgia has a retiree income exclusion starting at age 62 that becomes even more attractive each year and hits a maximum of $65,000 per year at age 65 and older.


You should not plan on converting any traditional IRA contributions unless you have sufficient cash reserves to pay the tax. If you pay the tax from the IRA funds being converted, you not only handicap the Roth from the beginning, but can also incur a 10% penalty if you are under age 59½. Tax considerations and the time value of money are key to the Roth IRA conversion. Timing conversions in years when your income is lower will minimize the amount of taxes paid, and the earlier in your career you start the better.


For those retirees who find themselves with large tax-deferred accounts, the early years of retirement, prior to the start of required minimum distributions, can be a great time to take advantage of conversions. Now that required minimum distributions do not begin until age 72, this gap period provides key planning opportunities. Retirees can capitalize on the reduction in their earned income to convert tax-deferred assets while minimizing the tax effect.


In 2021 for example, a married couple with taxable income up to $172,750 will be in the 22% tax bracket for federal income tax purposes. Keep in mind that this is their marginal tax rate. Their actual effective tax rate at this income level would be approximately 17%. Depending on income needs and available resources during this period, it is possible to use annual conversions to develop one prong of a three-prong withdrawal strategy. Building a withdrawal strategy that includes tax-deferred, Roth and non-qualified assets can provide both flexibility and tax efficiency.


When Roth IRAs Make Sense

In the case of a contributory Roth, if you do not have, or are ineligible to participate in, a retirement plan at work and are in a low tax bracket, a Roth IRA is a great choice. You may even be eligible for the saver's credit if certain criteria are met. On the other hand, if you are in a high tax bracket with no employer-sponsored retirement plan, it may be difficult to justify giving up the tax deduction now, especially if you are nearing retirement.

Contributing to a Roth IRA also makes sense if you have already contributed the maximum to employer-sponsored retirement plans, you are not subject to the income limitations, and you have sufficient nonqualified reserves. If you are subject to income limitations, but otherwise satisfy these criteria, a backdoor Roth is an excellent opportunity to accumulate some assets in Roth IRAs, provided of course that you can navigate the pro rata and aggregation rules.


When deciding whether to opt into the Roth option at your employer-sponsored retirement plan, you need to consider your current tax bracket versus your anticipated future one. Do not forget to include state income taxes in this calculation. For example, a single, high-earner New York City resident (current combined top tax rates of 49.696%) with plans to retire in Florida will likely have a lower combined tax rate in retirement. It is important to also consider the number of years until retirement. If you have enough time, the power of the tax-free growth can overcome the additional tax incurred up front. Consider a 50/50 approach where you defer 50% to Roth and 50% to traditional.

SECURE Act Considerations and Roth Conversions

With the passage of the SECURE Act at the end of 2019, Roth IRAs and, in particular, Roth conversions have seen a new surge in popularity. The combination of three key provisions — delaying required minimum distributions, removing age restrictions on IRA contributions and the repealed “stretch” provisions for IRA inheritors — has both retirement planning and estate planning implications.


The 10-year distribution rule requiring most non-spousal beneficiaries to distribute the entire inherited account within 10 years of the account owner’s passing can leave beneficiaries with a sizable tax burden. For those with large balances in traditional IRA accounts, converting can reduce future tax bills for both themselves and their heirs.


With many experiencing decreased incomes in 2020 and into 2021, the opportunity for conversions has presented itself to a broader range of taxpayers. You will still need to be aware of tax implications, including the potential for more of your Social Security benefits to be taxed and possible increases in Medicare premiums, but you may now have reason to look closer at whether a Roth conversion is right for you.



The Roth IRA can indeed be a valuable component in the retirement fund lineup. The tax-free growth and distributions can add significant value when designing withdrawal strategies and implementing estate plans. It is important to stay mindful of tax implications and to take advantage of both traditional and Roth IRAs based on your personal circumstances. Do not consider the decision to be all or nothing. It is not traditional versus Roth but rather a blended approach as your situation dictates.


If you have any questions about whether a Roth IRA makes sense for you, please contact your financial advisor.

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