Roth Rules for Retirees: Does Age Matter?

All this recent chatter about Roth conversions tends to dwell on the concerns of the well-off, which often means older investors.

Sorry, young people. You’re actually the best candidates for Roth IRAs. That’s because people with more investing years ahead of them are far more likely to find the math working in their favor, thanks to the progressive tax system and the snowballing effect of compounding.

With a Roth IRA, you get no tax deduction on contributions, but all withdrawals in retirement are tax-free, including the original contributions and investment gains. Traditional IRAs provide tax deductions on contributions if you meet certain requirements, but withdrawals are taxed as ordinary income.

There has been a lot of talk in recent months about new rules that took effect Jan. 1, allowing anyone to convert a traditional IRA into a Roth. Previously, only people earning less than $100,000 a year could do this. Obviously, much of the attention has focused on whether the over-$100,000 group should convert, which entails paying tax.

In most cases, the key factor is whether the investor’s tax bracket is lower when the conversion is done than when withdrawals are made. If it is, converting means paying tax at today’s lower rate to avoid tax at tomorrow’s higher one, and conversion probably makes sense.

But many older investors are in their highest earning years, and shoulder the highest tax rates of their lives. So, it’s likely they’ll be in lower brackets when withdrawing from their IRAs after retiring. For them, conversion would not pay. Why pay tax at today’s high rate rather than tomorrow’s low one?

But the picture is quite different for people in their 20s or 30s. Most people earn much less at the start of their working years than they will later, and their tax brackets are therefore lower than they will be later, possibly lower than they’ll be in retirement.