The Real Value in Roth Accounts and 8 Ways To Fund Them
Many people make the common mistake of accumulating most of their investments for retirement in pre-tax (tax-deductible) IRA and other retirement plan accounts, only to create a tax nightmare when the taxable Required Minimum Distributions (RMDs) are required to begin. Some major reasons for this costly oversight are some people are only focused on saving taxes TODAY and lose sight of the bigger, long-term picture, and may not fully understand the real value of Roth accounts and how they work.
In 1789, Benjamin Franklin wrote, “Our new Constitution is now established, everything seems to promise it will be durable; but, in this world, nothing is certain except death and taxes.”1 Death is still certain, but for the wise investors who understand Roth accounts and how to fund them, taxes can be eliminated if the rules are followed.
Benefits of Roth Accounts
There are certainly times when people should use pre-tax accounts, but we should always consider using Roth accounts when the opportunity arises because of 5 key benefits:
1. Tax-deferred Growth.
Just like pre-tax accounts, the funds within the Roth accounts accumulate tax deferred. Tax-deferred growth allows for your money to grow faster. In essence, you are earning returns on money that would otherwise go to pay taxes annually.
2. Qualified Distributions are 100% Tax-Free.
Unlike pre-tax retirement accounts such as Traditional IRAs and 401K plans, where distributions are always taxable, qualified distributions from Roth accounts are 100% tax-free if two conditions are met; the owner is over 59 1⁄2, dies, or becomes disabled, AND the account has been established for 5 years. The five-year clock begins January 1st for the year the first contribution was made or the conversion year. Example, if someone made a Roth IRA contribution in March of 2023 for the tax year 2022, then January 1, 2022, will be the start date.
3. Access to Contributions at any Age.
A unique feature of Roth IRAs is that contributions can be accessed at any age without taxes or penalties, allowing for versatile access to funds. Earnings distributed from Roth accounts that are not Qualified Distributions will be subject to taxes and penalties.
Access to tax-free Qualified Distributions during retirement can be very beneficial when funds are needed without unattractive tax consequences such as increased Social Security taxes or higher Medicare premiums.
4. No Required Minimum Distributions (RMDs).
Roth IRAs have never had RMDs, and now under the new Setting Every Community Up for Retirement (SECURE) ACT 2.0, Roth 401K plans will no longer have RMDs for owners age 73 to 75 depending on the year you were born. Age 73 for those born between 1951 and 1959, and 75 for those born in 1960 or later.
5. Roth Accounts can provide some Unique Estate and Tax Planning Considerations.
When someone plans to leave assets to family or charity, an important consideration is tax planning. If someone has pre-tax and post-tax (Roth) accounts, as well as after-tax non-retirement accounts, may present some attractive options for the account owners to decide which type of account(s) to use for their retirement income and which account(s) to pass on to beneficiaries with everyone’s tax brackets in mind.
8 Ways to Fund a Roth Account
With the many benefits of Roth Accounts discussed, it is surprising that only about 10% of taxpayers own Roth IRAs.2 Below are 8 ways to start funding Roth accounts.
1. Annual Roth IRA Contributions.
If you or your spouse has earned income for the year, you may be eligible to make a Roth IRA contribution for 2025 of $7,000 (plus a $1,000 catch-up contribution for those age 50 and older).
Earned income is defined as income from working as an employee or as a self-employed person, not income from rental, pension, or investments. Even children with earned income (chore money or part-time jobs) can make contributions. It would be wise to document their earnings annually if they are being paid for chores. Funding Roth IRAs at a young age can create tremendous wealth over a child’s lifetime and teach them an important wealth planning lesson.
If your child or grandchild has earned income but cannot afford to fund Roth IRAs, and you expect to leave them an inheritance, you might consider gifting them the amount they need to make Roth contributions. Now remember, gifts are gifts with no strings attached, but a donor could ask to see the year-end statement of the Roth account to verify contributions are being made, and no funds were distributed before making next year’s gift.
What better way than to transfer wealth tax-efficiently from one generation to another while still being around to teach and experience good wealth-building habits, rather than leaving sizable wealth to a generation that may not have the skills, habits, or experience to manage wealth wisely.
Contributions limits for 2025 are phased out for Married Filing Jointly starting at $236,000 Modified Adjusted Gross Income (MAGI) and totally phased out at $246,000 MAGI. The phase-out for Singles begins at $150,000 MAGI and is totally phased out at $165,000 MAGI.
If your income is too high to make annual contributions, you might consider increasing your pre-tax 401K contributions if that will bring your MAGI down to possibly permit Roth IRA contributions. If not, then consider option 2 below.
2. Backdoor Roth IRA Contributions.
For those who are not permitted to make Roth IRA contributions due to high MAGI, consider making contributions to non-deductible Traditional IRAs that do not have any phaseouts like Roth IRAs. Anyone with earned income can make a traditional IRA contribution regardless of their income, but the contribution may not be deductible based on Traditional IRA Deductible Contribution phaseouts. That’s OK though because when you withdraw from or convert non-deductible Traditional IRAs to Roth IRAs, you do not pay taxes on those contributions because the contribution was not tax-deductible (pre-tax).
For example: If you only had a non-deductible IRA where you made total contributions of $50,000 over the years and the value grew to $100,000, if you were to convert 100% to a Roth IRA you would only pay taxes on $50,000 but have $100,000 in the new Roth IRA. Be aware that pro-rata rules apply when you own other tax-deductible (pre-tax) IRA accounts.
3. Roth IRA Conversions.
Any person at any age, with or without income, may convert tax-deductible (pre-tax) Traditional IRAs to Roth IRAs if the person is willing to pay income taxes on the amount converted in that particular year. The ideal time to do Roth conversions are in years with low-income tax rates which are typically early retirement years for those who wisely invest in non-retirement, after-tax investments that can allow for lower taxable retirement income before Social Security and RMDs.
4. 401K After-Tax Rollover to Roth IRA.
Some company retirement plans, such as 401(k)s, allow for after-tax contributions so that when the employee leaves the company, does an in-service distribution, or retires, they can roll over the after-tax balance to a separate Roth IRA from the pre-tax balance. This needs to be done at the time of the rollover, not afterward, and keeps the accounting clean and promotes the ability to fund Roth IRAs.
5. Inherited 401(k) After-Tax Rollover to Inherited Roth IRA.
Like number 4 above, beneficiaries can also roll over after-tax balances to an Inherited Roth IRA.
6. 401(k) and 403(b) Roth Contributions.
For company retirement plans who offer Roth Contributions, a plan participant needs to decide if pre-tax contributions or after-tax Roth contributions are in their best interests. It may be wise to take advantage of both depending on a person’s current tax situation and view of future tax rates. For 2025, the combined total limit is $23,500 (regular) plus a $7,500 catch-up for those age 50 and over for a total of $31,000. A super catch-up for those ages 60-63 for a total of $34,750.
7. Solo Roth 401(k).
Self-employed individuals have many options for funding retirement accounts, including a Solo 401(k) plan that can allow for Roth contributions as well.
8. Conversion of a 529 College Savings Plan to a Roth IRA.
529 plans are a great way to save for educational expenses, and now with the new Setting Every Community Up for Retirement (SECURE) Act 2.0, excess funds left in 529 plans can be rolled DIRECTLY into a Roth IRA for the child (beneficiary) provided the child is eligible for Roth contributions, and the 529 plan has been established for 15 years. A lifetime total of $35,000 can be rolled over from 529 plans at a maximum of $7,500 per year if the child has earned income of that amount.
Bringing It All Together
Retirement accounts, including the pre-tax and after-tax Roth accounts, should be considered, in addition to non-retirement after-tax accounts, for our retirement planning.
Each of these three types of accounts offers different tax planning opportunities, but it is very hard to argue against the Roth accounts offering potentially tax-free distributions when they are available.
Plan with confidence. Live with purpose. Harvest wisely.
About the Author
Tim Hudson, CFP®, APMA®, CEPA, CLU, ChFC, CRPS®, is a Certified Financial Planner® and Certified Exit Planning Advisor® and has over 25 years of experience specializing in advanced investment, retirement, business, and estate planning strategies designed to help high net worth individuals and business owners grow, preserve, and distribute wealth tax-efficiently.
Tim founded Wealthtrition.com to provide advanced wealth education, resources, and planning services for individuals and business owners.
You can reach Tim at (281) 477-3847 or tim@SilverStarWealth.com.
SilverStar Wealth Management, Inc.
17844 Mound Rd., Suite E, Cypress, TX 77433
(281) 477-3847 | www.SilverStarWealth.com
Important Disclosure
This material is intended for informational purposes only and is not intended to be a substitute for specific individualized tax or legal advice, as individual situations may vary. Securities offered through Kestra Investment Services, LLC, member FINRA/SIPC (Kestra IS). Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS). SilverStar Wealth Management, Inc., Bluespring Wealth Partners, LLC, Kestra IS, and Kestra AS are affiliated through common ownership by Kestra Holdings.
Investor Disclosures: www.kestrafinancial.com/disclosures
You should consult with appropriate financial, tax, or legal professionals before implementing any considerations discussed.