What Baby Boomers Need to Know About Roth IRAs – Investopedia

If you’re a baby boomer, born between 1946 and 1964, chances are you’ve been saving for retirement for several decades now. If any of your accounts are Roth IRAs—or if you’ve thought of adding a Roth IRA to the mix—here is what you need to know.

Key Takeaways

  • A Roth IRA can be a source of tax-free income in retirement.
  • If you convert a traditional IRA into a Roth IRA, you’ll have to pay income tax on that money right away.
  • Unlike traditional IRAs, Roth IRAs have no required minimum distributions (RMDs) during your lifetime, so they can be useful for estate-planning purposes.

What Is a Roth IRA?

Roth IRAs, which first became available in 1998, work much like traditional IRAs, except for when you get a tax break. With a traditional IRA, you can take a tax deduction for the money you contribute, but you’ll be taxed on that money and its earnings when you eventually withdraw it. With a Roth IRA, on the other hand, you don’t receive any tax break up front, but your withdrawals, including both your original contributions and the account’s earnings, will be tax free if you follow the rules.

Advantages of Roth IRAs

Roth IRAs have a couple of advantages over their traditional counterparts that some people may find especially attractive. For one, you can withdraw your contributions to a Roth IRA (but not their earnings) at any time without taxes or penalties. With a traditional IRA, you’ll generally owe income tax on the money, plus a 10% penalty if you’re under age 59½. That makes the Roth a ready source of funds if you ever need the cash for a financial emergency or other purpose. 

Also, unlike their traditional counterparts, Roth IRAs are not subject to required minimum distributions (RMDs) during your lifetime. So if you don’t need the money for living expenses after you retire, you can just allow it to continue to grow, tax free, and eventually leave it to your heirs. They will, however, have to withdraw it at some point, typically within five or 10 years, depending on their relationship to you.

Roth IRA Withdrawal Rules

If you have a Roth IRA, you’ll need to heed a couple of rules in order to reap the full benefits of its tax-advantaged status. Specifically, you must have had a Roth IRA account (any Roth account) open for at least five years, and you must be at least 59½ to withdraw your account’s earnings tax free. There are some exceptions, including one for disability.

Starting a Roth IRA

If you don’t already have a Roth IRA but would like to start one, you have three options: open a new account, convert a traditional IRA into a Roth IRA, or roll over a 401(k) plan account into a Roth IRA. Here’s a look at each.

Opening a New Roth IRA

To contribute to a Roth IRA, you’ll need earned income, so if you work either full time or part time, you may be eligible. There are also income limits. For 2022, for example, married couples who file a joint tax return can make a full Roth IRA contribution if their modified adjusted gross income is under $204,000. If it’s between $204,000 and $214,000, they’re eligible for a reduced contribution; above $214,000, they’re ineligible to contribute. The maximum IRA contribution for 2022 is $6,000 ($7,000 if you’re 50 or older).

Converting a Traditional IRA Into a Roth IRA

If you have a traditional IRA, you can roll all or part of it into a Roth through a Roth IRA conversion. Aside from any inheritance considerations, whether a conversion makes sense for you is basically a matter of whether you’d prefer to take a tax hit now and avoid taxes in the future (by converting to a Roth) or continue to postpone the tax hit and deal with it later (by staying with your traditional IRA). Of course, it doesn’t have to be an all-or-nothing choice; you can convert a portion of your traditional IRA and leave the rest where it is.

You’ll owe income tax on the money you take out of your traditional IRA to put into your Roth, just as if you were withdrawing it to spend. If you’re planning to convert a sizable amount, you’ll want to take a close look at your current highest marginal tax bracket and possibly spread the withdrawal over several years.

For example, in 2022 a single taxpayer is taxed at 24% on income between $89,075 and $170,050 and at 32% on income between $170,050 and $215,950. Thus, a single taxpayer who earns $100,000 a year could convert up to $70,050 and pay 24% tax on the transaction. Anything more than that would be taxed at a rate of 32% or higher.

Timing a Roth Conversion

Timing is important here. Suppose, for example, that our single taxpayer is about to retire from their $100,000 job and expects to have a retirement income from all sources of $50,000, giving them a highest marginal tax rate (pre–IRA conversion) of 22%. They could convert as much as $120,050, paying 22% tax on the first $39,075 (the 22% bracket ends at $89,075) and 24% on the remainder. Convert any more and it would hit the 32% bracket or higher.

Similarly, if your income is lower in any particular year for another reason, such as a job loss, that could be a good opportunity to do a conversion if you wish to do so. You might also have a few years of reduced income if you retire at, say, 66, but delay taking Social Security benefits until they max out at age 70. And keep in mind that after age 72, you’ll have to begin taking RMDs from any non-Roth retirement accounts, which could put you back into a higher marginal tax bracket.

Converted Roth Withdrawal Penalties

Note that there can be a 10% penalty if you withdraw any of the money you converted within the first five years of opening a Roth account. However, there’s an exception for anyone over 59½, as virtually every baby boomer already is or soon will be. 

Also, you will have to wait five years before withdrawing any of the new Roth account’s earnings unless you already had another Roth IRA for at least five years before you made the conversion. That could be a deal breaker for some older baby boomers or anyone who expects to need the money before the five years is up.

Rolling Over a 401(k) Into a Roth IRA

If you’re leaving your job, or if you left an old 401(k), 403(b), or 457(b) plan account behind at a previous employer, you can roll that money over into an IRA, either Roth or traditional. If you go the Roth route, you’ll owe taxes on the money just as you would if you converted from a traditional IRA to a Roth. You can also roll a portion of the money into a Roth and the rest into a traditional IRA for the time being, which may ease your tax burden if a lot of money is involved.

If your 401(k) or similar plan is a designated Roth account, you can roll it over into a Roth IRA with no tax consequences. However, you may have to pay tax on your employer’s matching contributions, which are held in a separate account. One advantage of a Roth IRA over a designated Roth 401(k) is that it is not subject to RMDs during the original owner’s lifetime, while the 401(k) is.

Can I Convert a SEP IRA Into a Roth IRA?

Yes, any money you have in a simplified employee pension (SEP) IRA is also eligible for rolling over into a Roth IRA. As with a traditional IRA, you’ll have to pay income tax on the money you convert.

What Is a Backdoor Roth IRA?

A backdoor Roth IRA refers to a strategy employed by some taxpayers whose incomes are too high for them to qualify for a Roth IRA in the usual way. Basically, they open a traditional IRA, then roll over that money into a Roth. Traditional IRAs have no income limits, although the extent to which contributions are deductible depends on the person’s income and whether they have a retirement plan at work.

Are Backdoor Roth IRAs Legal?

Backdoor Roth IRAs are legal, although there have been some moves in Washington to curtail their use, including provisions in the Biden administration’s Build Back Better plan. However, that legislation appears to be in limbo.

The Bottom Line

Baby boomers, like other generations, can benefit from having a Roth IRA in retirement, but there are trade-offs. There’s no up-front tax break for contributions to a Roth account, and converting a traditional IRA into a Roth can mean a big tax bill. The major question is whether you’d rather pay taxes now in return for tax-free income after you retire.

Another consideration for some people is whether you hope to leave the money to your heirs. Because Roth IRAs aren’t subject to RMDs, they can be better than traditional IRAs for that purpose.