Tag: Roth IRA

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Catch-up contributions to retirement plans

The IRS recently changed retirement savings plans, like 401(k) plans offered by many employers, for workers nearing retirement. Previously, workers 50 and over could make catch-up contributions. Starting in 2025, employees between 60 and 63 can increase these catch-up contributions by an additional 14%, according to this WSJ article. In this post, we discuss why many workers may want to take advantage of this new rule.

401(k) plan contributions

Employee contributions to 401(k) plans were originally established to encourage growing a nest egg for retirement. By contributing pre-tax income, workers could also reduce their current-year taxable income. For older workers who were unable to save earlier in their careers, these catch-up contributions can help retirees meet their savings goals. Also, as many workers enter their 50s, their income often peaks. So, the deferred taxes on 401(k) contributions may provide an added benefit if income is lower in retirement.

Retirement plan catch-up contributions change for 2025.
Retirement plan catch-up contributions change for 2025

Pre-tax or after-tax contributions to a 401(k)

Workers may also have an option in their retirement plan to contribute to a Roth 401(k) plan using after-tax contributions. While these contributions don’t provide the immediate tax deferral of the traditional 401(k) contribution, they do provide tax-free retirement income. Roth 401(k) contributions also help workers save after-tax dollars and avoid the income limit for direct contributions to a Roth IRA. To make a full Roth IRA contribution in 2024, single filers modified adjusted gross income (MAGI) must be under $146,000, and joint filers under $230,000. Alternatively, some workers and retirees may consider a Roth conversion. For large emergency expenses that may occur during retirement, such as medical-related expenses, retirees can use after-tax retirement savings in Roth accounts to avoid higher tax brackets.

Not sure what to do next with your catch-up contributions?

We offer a free simulator to see if you can reach your retirement savings goal.

Retirement plan catch-up contributions change for 2025.
Our free savings calculator simulates future market conditions to assess saving goals

You can use this tool to see how pre-tax or after-tax contributions may affect your future retirement savings. We hope you find this tool educational!

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
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When a Roth Conversion May Be Right for You

A Roth conversion typically moves pre-tax funds from an Individual Retirement Account (IRA) to a Roth IRA. Doing so adds income to the year when account holders convert, so may trigger additional income taxes. But, future withdrawals from the Roth IRA should be tax-free. We’ve discussed some research on this topic before in our article published in the Financial Planning Review. Ed McQuarrie, Emeritus Professor from Santa Clara University just published another article on the topic. It now appears on page 76 in the September 2024 edition of the Journal of Financial Planning. This post will highlight the key findings in this important research related to retirement income and estate planning. We also highlight how our retirement income calculator aligns with these insights for a retiree’s particular scenario.

Roth conversion article by Ed McQuarrie entitled "Net Present Value Analysis of Roth Conversions"

New research contribution

Prof. McQuarrie’s research focuses on the Roth conversion’s Net Present Value (NPV). NPV is an important metric used to value projects, which states that discounted future cash flows must sum to a positive number to add value to the project’s owner. His journal article highlights when NPV turns positive based on the time since the conversion occurred,

Figure 2 from Net Present Value Analysis of Roth Conversions by E. McQuarrie, Journal of Financial Planning, Sep 2024.
Figure 2 from Net Present Value Analysis of Roth Conversions by E. McQuarrie, Journal of Financial Planning, Sep 2024.

As Figure 2 demonstrates, a positive NPV occurs when the retiree reaches age 86. More or less favorable assumptions about future tax rates can decrease or increase the time for NPV to turn positive, and this article highlights a few insightful examples.

Risks in future tax code and individual circumstances

The article continues by discussing several risks faced by a Roth conversion. For example, since the U.S. Congress sets tax laws, taxpayers will never know for certain what income tax rates may be in the future. The Tax Cut and Jobs Act (TCJA) that expires in 2025 may or may not be extended or modified in ways that are favorable to a Roth conversion today. Also, consideration of an heir’s tax rate is important for retirees who have excess funds they wish to pass on after their death. Heirs at lower tax brackets, and certainly heirs who are charitable organizations who may not owe tax on IRA bequests, may benefit more financially in receiving assets from an IRA rather than a Roth IRA. Conversely, a surviving spouse utilizing the standard deduction could significantly benefit from a conversion before the passing of their spouse.

How to assess a Roth conversion for your situation

Given all these complexities, a thoughtful analysis is important before making a Roth conversion. One approach is to use software, like our Retirement Income Calculator. And, given this latest research, there are many nuances to consider before conducting a Roth conversion. This research article nicely highlights four scenarios when a conversion is the least risky and four scenarios when they are most risky and is worthy of review for anyone considering a Roth conversion in the coming years.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs

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The Roth 401(k) for retirement

The Roth 401(k) has been slowly growing in popularity since its creation in 2006. According to this WSJ article, over 80% of employer retirement plans now offer these. In this article, we will discuss this relatively new way to accumulate retirement savings and the trade-offs made when using one.

Roth 401(k) plans continue to grow.

Pay taxes now or later

Employers that offer both traditional 401(k) and Roth 401(k) plans give employees greater control over when taxes are due on their retirement savings. An employee can defer taxes on retirement contributions with a traditional 401(k) plan. These contributions will likely reduce their current taxable income and consequently the amount of taxes owed during each working year. Additionally, gains in a traditional 401(k) plan grow tax-deferred. However, ordinary income taxes are generally due on future withdrawals or on Roth conversions of these tax-deferred plan assets rolled into an IRA.

Conversely, when an employee contributes to a Roth 401(k), there is no tax-deferred benefit. Instead, the contributions are part of their current year’s income. However, once the funds are in the Roth 401(k), like in a Roth IRA, the funds grow tax-free. Additionally, qualified withdrawals during retirement are generally tax-free.

Pros and Cons of a Roth 401(k)

Retirees gain the most obvious benefit from a Roth 401(k) when future taxes are higher. For example, if the Tax Cuts and Jobs Act (TCJA) from 2017 expires at the end of 2025 without the U.S. Congress intervening, tax rates will revert to pre-2017 levels, which are higher than current rates. Additionally, younger workers who expect significant wage growth may also benefit from the Roth 401(k). And, if there are unexpected large expenses in retirement, having some after-tax funds can help retirees avoid spikes in taxable income.

If you are not sure how much to contribute to a Roth 401(k), you can follow research by David Brown, an associate professor of finance at the University of Arizona. His research suggests a rule of thumb where you add 20 to your age and put that percentage into a traditional 401(k), with the rest in a Roth 401(k). For example, a worker who is 45 should put 65% of their 401(k) savings in pre-tax contributions, and the remaining 35% as after-tax Roth 401(k) contributions.

Our software may help

We offer two online software tools to help in this planning decision. The first can predict future retirement savings balances across tax-deferred, tax-exempt, and taxable accounts based on future contribution amounts. The second can predict the longevity of your portfolio, or what your non-spouse heirs may expect for an inheritance, based on the U.S. progressive tax system. We encourage you to use tools like these to better understand savings decisions made today to meet your future retirement goals.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs

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The Arithmetic of Roth Conversions

In our recent posts from March, April, and May 2023, we highlighted some important considerations when making a Roth conversion. In this post, we continue this conversation with a recent article published in the May 2023 edition of the Journal of Financial Planning, entitled “The Arithmetic of Roth Conversions”. I was very fortunate to co-author this article with my colleague Dr. Edward McQuarrie, Emeritus Professor at Santa Clara University.


McQuarrie, Edward F., and James A. DiLellio. 2023. “The Arithmetic of Roth Conversions.” Journal of Financial Planning 36 (05): 72–89.

Executive Summary

• Roth conversions continue to vex planners. To clarify matters, this paper submits conventional rules of thumb to a strictly arithmetic analysis.

• The treatment shows that it must be optimal to pay tax outside the conversion with cash, confirming one common rule. But if tax must be paid to raise the cash used to pay the conversion tax, there will be an initial loss on the conversion and a subsequent breakeven point. This paper shows how to determine time to break even.

• By the same arithmetic, the paper refutes the common rule that future tax rates must be higher for a conversion to pay off. Given enough time, conversions can overcome moderately lower future tax rates and still produce a substantial payoff due to the power of compounding.

• Most Roth conversions will show a substantial payoff if the client’s planning horizon stretches over decades; however, shorter time frames may produce only a minimal payoff or even a loss.

• The paper gives practical advice regarding the optimum time to convert, points in the tax structure that favor or disfavor conversion, and the clients most and least likely to receive a substantial payoff from conversion.

Key points to consider when reviewing “The Arithmetic of Roth Conversions”

This article highlights the importance of the following key items:

  1. Current and future tax rates
  2. How time can help a conversion generate a positive payoff
  3. The type of retirees well suited and not suited for Roth conversions

We also encourage you to try our retirement income calculator. It was recently updated to include both optimal account drawdowns and Roth conversion analysis.

We hope you find this latest research article helpful in your own retirement planning or your financial planning practice!

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
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Roth Conversions that Payoff

Roth conversions for retirees and individuals nearing retirement often confuse financial planners and individual investors. In this post, we discuss the pros and cons of converting a portion of tax-deferred assets to a Roth IRA. The insights I share here reflect early results from a recently conducted research initiative.

Why Convert to a Roth IRA?

Converting funds from a tax-deferred account, like a 401(k), 403(b), traditional IRA, or rollover IRA, may seem counterintuitive to many. Indeed, in my recent award-winning article on Seeking Tax Alpha in Retirement Income, which will soon appear in the Financial Services Review, I highlighted how many tax professionals, like CPAs, generally advocate deferring taxes for as long as possible. Converting funds to a Roth IRA imposes a current tax liability, contradicting this conventional wisdom. However, the communicative law of multiplication suggests otherwise for funds converted at the end of the year. A positive payoff occurs when the current marginal tax rate is less than the future marginal tax rate. Stated more simply:

Always seek the lowest marginal tax rate, either now, or in the future, when converting, or distributing tax-deferred assets.

Adapted from DiLellio and Ostrov (2017) “Optimal Strategies for Traditional versus Roth IRA/Roth 401(k) Consumption During Retirement”, Decision Sciences Journal. 48(2).

Tax Alpha from Converting to a Roth IRA

In my recent unpublished research results with Ed McQuerrie, we propose to show the benefit of Roth conversions in terms of tax alpha or the additional annual return realized by converting. If a distribution from the Roth IRA then pays the taxes, the figure below shows the tax alpha over a number of holding periods, from five to 40 years. We see that when future tax rates are higher, there is a significant benefit, but that tax alpha diminishes over time. Similarly, if an investor converts their tax-deferred assets and the future tax rates are lower, the negative payoff can be significant initially, but the loss will also diminish over time.

Tax Alpha from Roth Conversions if future marginal tax rates are 50%, 95%, or 150% of the current marginal tax rates
Tax alpha if future marginal tax rates are 50%, 95%, or 150% of the current marginal tax rates

The Challenge to Roth Conversions

The U.S. Congress sets tax rates. So, we can’t know future tax rates with certainty. But, a retiree is able to control the amount of ordinary income generated by distributions from tax-deferred accounts. Also, the results above assume the investor is at least 59 1/2 so they can avoid the tax penalty on early withdrawals to fund the tax liability. In our next post, we will highlight some beneficial results if an investor pays conversion taxes with a non-retirement account.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs