Many people want to know whether it makes sense to contribute to and/or convert funds into Roth accounts. In this article, I will outline the considerations families ought to have in mind — tax and otherwise — when deciding whether “to Roth or not to Roth.”

First, a little background on the origins of the Roth. William Roth was a senator from Delaware; in 1998, he sponsored a bill that created a new type of retirement account, which was dubbed the Roth IRA (the Roth 401(k) came along eight years later). The Roth IRA retained many of the features of the standard IRA, such as contribution limits, income tests, and tax deferred growth, and then added two more key elements: Roth contributions would be made with after-tax dollars and the savings and earnings would be tax-free upon withdrawal (provided a few requirements were met).

The introduction of the Roth was a significant change, as a generation of savers had been utilizing IRAs and employer-based qualified retirement plans like 401(k)s in order to delay paying income tax on investment accounts for as long as possible. Contributions to these traditional accounts reduced savers’ taxable income in the year of the contributions (meaning they do not pay income tax on the funds at the time they are deposited), requiring instead that all withdrawals be treated as taxable income in the year they are withdrawn. In other words, savers defer paying income taxes on their savings until they use those savings.

The Roth works this math in the opposite direction: Roth contributions are made with after-tax dollars (taxable income is not reduced and tax is paid on all current income), but then those savings and any investment earnings are tax-free when it comes time to use them. Utilizing a Roth account is essentially betting that today’s effective tax rate is lower than what you will face when withdrawing funds in the future, either because general tax rates increase, your personal tax rate increases, or you have significant earnings that would add to your tax burden.

1. General increased taxes

We have no crystal ball or other predictive powers that tell us where tax rates are headed, but the writing is on the wall that individuals will be facing higher income taxes in 2026 than they are now after the expiration of the 2017 Tax Cuts and Jobs Act. Beyond that requires some educated guessing, but the current $1 trillion deficit suggests that taxpayers may be asked to contribute more going forward. If you believe federal income tax rates are substantially lower now than they will be when you retire, consider funding Roth accounts.

2 & 3. Increased rates specific to particular taxpayers

There are a variety of taxpayer-driven reasons why marginal rates may be higher for an individual in retirement than they are while working. Two of the most common taxpayer-driven reasons for higher tax rates are: deferred compensation payments and retiring to a state that assesses an income tax. If you are expecting to receive deferred compensation in retirement, or if you are living in a state with no income tax now and you expect to retire to a state that does assess such a tax, consider funding Roth accounts.

Another taxpayer-driven reason individuals are faced with high marginal tax rates in retirement occurs when they derive a large portion of their income from real estate and are carrying substantial IRA balances. For these families, the required distributions that begin at age 72 are more of a burden than a blessing. Because their cash flow needs are being met by real estate income, the required minimum payments, combined with Social Security, can push them into higher tax brackets. By the time retirees get to this point, there are often substantial gains preventing them from selling out of the real estate. If you intend to maintain substantial income-generating real estate holdings through retirement, consider funding Roth accounts.

4. Social Security and Medicare Planning

Income planning in retirement often involves factors that are based on taxable income (for example, determining the taxation of Social Security payments, managing marginal tax brackets, or calculating Medicare Part B and Part D premiums). Having a lower taxable income via tax-free Roth withdrawals can help maximize your take-home Social Security payments and minimize your Medicare Part B and D premiums (This is a relatively small planning area for most families, as there are a variety of factors that come in to play in these calculations and the brackets for the applicable tests are narrow). If this is important to you, consider funding Roth accounts.

5. Tax-efficient Cash Flow in Retirement

The tax-free growth and tax-free withdrawals offered by Roth accounts makes them ideal accounts for managing retirement cash flow. On one hand, underlying asset growth does not generate tax liability (as it would in a taxable account) and on the other, withdrawals are income tax-free (unlike IRAs and traditional retirement plans). The ability to minimize capital gain exposure and income tax liability makes the Roth the ideal account to manage tax liability — in years when taxable income is high, extra spending comes from the Roth. In years when taxable income is low, withdrawals instead come from the traditional retirement vehicles. If you are looking to generate this sort of tax-efficient income in retirement, consider funding Roth accounts.

6. Beneficiary considerations

One more difference between Roth and tax-deferred accounts relates to the beneficiaries who inherit the funds. The beneficiary of a Roth receives the funds tax-free, while beneficiaries of traditional IRAs and/or traditional retirement accounts must pay income taxes as they withdraw funds from those accounts. The recently passed SECURE Act forces the beneficiaries of IRAs and traditional qualified plans to withdraw the entire account balance within ten years of the account holder’s death. This means that if parents leave their traditional IRA to one child and their Roth IRA to another, one of the children is going to have additional income to report to the IRS over the next ten years (and tax to pay), while the other does not. The difference between inheriting a Roth versus a traditional IRA (or other qualified plan) is especially important when beneficiaries are employed and earning substantial income on their own, as that may be a very bad time to add taxable income to beneficiaries’ returns. If your children are likely to be in their peak earning years when they inherit assets, consider funding Roth accounts.

7. Aggressive Investments and Private Equity

The long-term structure, tax-free growth, and tax-free withdrawals afforded by Roth accounts make them an ideal place to hold the highest-octane positions in a portfolio. Roth accounts also require no annual tax reporting, so investors holding private equity inside of a Roth need not concern themselves with K-1s. If you are an investing in private equity and looking for the ultimate vehicle through which to transfer these long-term volatile positions to the next generation, consider funding Roth accounts.

Weighing all of the tax and non-tax factors that come into play with Roth accounts can be a bit overwhelming (to say nothing of navigating contribution limits, income thresholds, and rollover techniques). If you are looking for an easy way to get started with a Roth, see if your workplace retirement plan offers a Roth option. Funding your workplace retirement account with up to 50% of contributions to the Roth side of the ledger is a good way to hedge your bets on future tax rates (this is called “tax diversification”).

If you have questions about the best way to divide your savings among traditional and Roth accounts, or whether to fund Roth accounts at all, please feel free to contact our wealth planning team at any time.