A Roth IRA is a powerful tool for growing and preserving wealth, as it not only grows tax free but also allows distributions to be taken tax free. From Roth conversions to backdoor Roth accounts, taxpayers can take advantage of Roth IRAs to sustain wealth — they just need to know which one is right for them.

BACKGROUND: ROTH IRAS

With Roth IRAs, there is no Required Minimum Distribution (RMD) age, much like a traditional IRA or 401(k) retirement plan. Distributions cannot be taken until age 59 ½ in order to avoid penalties and taxes on the earnings though. After this age, all earnings and distributions are tax free. One caveat is that if the Roth plan is at least five years old, taxpayers can take distributions penalty free but must still pay taxes on the earnings.

Individuals who inherit Roth IRAs can take distributions tax free regardless of their age, but they are generally required to distribute all inherited Roth IRA assets by the tenth anniversary of the decedent’s passing.

When funding a Roth IRA, contributions are made with after-tax dollars and can be done at any age as long as the individual has earned income, such as wages or self-employment income. The maximum annual contribution limit into a Roth IRA is $7,000 ($8,000 for individuals over the age of 50) for 2025 and $7,500 ($8,600) for 2026. Those that wish to contribute the max amount for tax year 2025 must have Adjusted Gross Income (AGI) of $150,000 or less for single filers and $236,000 or less for joint filers.

Taxpayers earning more than the cap for a given year may consider a Roth conversion to contribute more than the max amount. 

THE DETAILS: ROTH CONVERSION 

A Roth conversion is a direct transfer of cash or assets from a traditional IRA or 401(k) account to a Roth IRA. This allows taxpayers to fund a Roth despite the AGI limitation imposed under Roth IRAs. A traditional IRA to Roth IRA conversion is the most common and simple approach to this, while a 401(k) conversion may be more involved administratively. This often depends on the provisions of the 401(k) plan and may require waiting until the individual leaves their current employer before they can complete the conversion. 

There is no limit to the number of Roth conversions a taxpayer can do in their lifetime.

Tax Consequences of a Roth Conversion

There is a one-time tax on the amount an individual converts into a Roth. For example, if in 2025, someone was to convert $150,000 from their traditional IRA to a Roth IRA, they would be taxed on that $150,000 as ordinary income on their 2025 tax return. It is important to note that the portion of the $150,000 that represents prior non-deductible contributions to the traditional IRA would not be included in taxable income. In other words, account holders are only taxed on the converted amount that consists of prior deductible contributions and any post-contribution earnings. 

In this exercise, taxpayers should consider their tax bracket and marginal tax rate. High earners may want to wait to do a conversion until a year when they will be in a lower bracket. The strategy here is to reduce a taxpayer’s overall taxes on the conversion itself. Typically, for high earners, they should look to do this after retirement but before they have to take RMDs on their traditional IRA or 401(k). 

For those currently in lower tax brackets looking to minimize taxes, they may consider converting enough to stay in a lower bracket than they currently are or expect to be upon retirement. This is often where individuals choose to complete multiple conversions spread over several years to keep taxes to a minimum.

Tax Strategy of a Roth Conversion

The key to making a Roth conversion worthwhile is ensuring funds are invested correctly so that they appreciate significantly over the years. As with traditional IRAs, there are rules regarding permissible investments for Roth accounts. 

Another consideration is having the account holder’s heir(s) inherit their Roth IRA. In these instances, they may be able to defer distributing any cash or assets for up to 10 years after the account owner’s passing, allowing the assets to continue to grow tax free for some time. 

THE “BACKDOOR ROTH” CONCEPT

Individuals with higher income or those without a traditional IRA account can look to the backdoor Roth concept. Taxpayers can open a traditional IRA account and make the maximum annual contribution as a non-deductible (or “post-tax”) contribution. They then immediately convert the entire amount of the traditional IRA contribution to a Roth IRA. If there are no earnings in the traditional IRA account as a result, the conversion is entirely tax free. Waiting to convert, though, after there have been earnings means that the earnings component is subject to ordinary income tax. 

PRESERVING WEALTH WITH A ROTH IRA

Ideally, Roth conversions are made in a year when the individual’s taxable income is low or lower than usual. 

Individuals that have just retired but do not need to draw on their retirement account(s) yet may want to start doing conversions between retirement and the time they have to start taking RMDs from the IRA or 401(k). By converting now, individuals can reduce their RMD later, as the conversions will reduce their overall traditional IRA and/or 401(k) accounts.

Further, paying tax now on a conversion can support greater potential for wealth accumulation in a Roth. For example, assume someone converts $100,000 to a Roth and has to pay 25% taxes between federal and state on that converted amount. The individual could recover the tax amount inside the Roth account in less than five years with a 5% return compounded annually. If their time horizon is 15-25 years and returns are larger than 5%, then the tax-free wealth accumulation would be substantial. Leaving contributions in the Roth account for an heir to inherit would also add a potential 10-year horizon before they eventually distribute the assets.

To learn which Roth approach is best for you and your legacy, talk to the High-Net-Worth Individuals Practice at GHJ.