Roth Conversions and the SECURE Act: Pros and Cons

When Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2019, several advantages were created for persons using Roth IRAs or 401(k) plan accounts to prepare for retirement. Perhaps one of the biggest advantages of the act—though it doesn’t apply specifically to Roth accounts—is that it extends the age for beginning required minimum distributions (RMDs) from retirement accounts from 70 ½ to 72. This means that for those who are not dependent on the income from their traditional IRA or 401(k) plan, receiving taxable income in the form of RMDs can be delayed for an additional year and a half. For individuals in higher tax brackets in retirement, this means a reduced tax bill in April.

The reason this doesn’t apply to Roth accounts is because of one of the main differences between Roth and traditional retirement accounts. While traditional IRAs, in general, and 401(k) plan accounts provide a tax deduction for the funds deposited each year before retirement, Roth accounts do not. On the other end of the process, when funds are withdrawn from a traditional account in retirement, they are taxed as ordinary income (since they were never taxed before), while withdrawals from Roth accounts are not subject to taxation. So, Roth withdrawals in retirement are transparent, tax-wise, for most account holders. Another reason the longer time until RMDs are required under the SECURE Act doesn’t apply to Roth accounts is because Roth accounts have no RMDs; the account owner or qualified spouse can leave the funds in the account until their death, with no penalties or other tax consequences.

And this brings us to the first disadvantage for Roth account holders (and traditional account holders too, for that matter) created by the SECURE Act. Formerly, the account holder could pass ownership of an IRA or 401(k) account to a beneficiary—often a child or grandchild—upon the account holder’s death. And it used to be the case that the beneficiary had their entire lifetime to withdraw funds from the account (sometimes called a “stretch account”), easing the tax burden that would be created by taking larger amounts of taxable income over a shorter period of time. But the SECURE Act eliminated this provision. Now beneficiaries—usually excluding the deceased owner’s spouse—have a maximum of ten years to withdraw the funds from the inherited account without facing penalties.

When Roth accounts became available, many holders of traditional accounts found it advantageous to convert their accounts to Roth accounts. This is especially true for those who believe that they might be in a higher tax bracket in retirement than during their working lives. While converting a traditional account to a Roth account requires paying taxes on the converted amount, it may make sense to do so if you believe you will pay lower taxes now than if you waited to pay taxes on the funds when withdrawn in retirement.

This brings up another advantage of the Roth conversion: it can allow the account holder to transfer more funds to heirs, since the money withdrawn by the heirs is not subject to taxation, whether withdrawn as a lump sum or over the allowed ten-year period. In fact, an heir could allow an inherited Roth account to continue accumulating tax-free for the full ten years, then withdraw all the money at once, thus gaining the maximum benefit of tax-free compounding and growth.

If you have questions about Roth conversions, the best way to pass assets to heirs, or other matters, we would love to offer our professional expertise to you; please feel free to contact us. If you’d like to read our recent article offering tips on saving for retirement, click here.

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