You must have earned income (compensation) in order to contribute to a Roth IRA. The annual amount you can contribute to a Roth IRA is solely dependent on your adjusted gross income as determined on your federal income tax return.

Jeff has referred to the Roth IRA as “the greatest thing since sliced bread” and I have to say, I agree wholeheartedly. Today I’d like to discuss how you can use a Roth IRA  to maximize the amount of wealth you can generate. Read that last sentence as “minimize your taxes over time.” Who doesn’t want to minimize the amount of taxes you pay over time?  Am I trying to tell you that depositing all your retirement savings into a Roth IRA, or converting as soon as you are permitted is not the best route for everyone? Exactly.

Let’s start with a quick explanation of Roth IRA vs traditional retirement accounts (this can be either an IRA or 401(k) as each offer the Roth variant). A traditional account permits you to take a tax deduction for deposits going into the account, in which the money would grow, tax-deferred, and taxed upon withdrawal at your prevailing marginal rate. The Roth account is a bit of a mirror image of this, the deposits are made with post-tax money, but both the growth and subsequent withdrawals are made tax free. In a sense, the decision comes down to one question – will you be in a higher tax rate at withdrawal time?

If only it were that simple…

There’s another option, conversion, which Jeff discussed in his post “The 2010 Roth IRA Conversion Is Coming.” So if only I had a magic wand, I’d wave it and produce a chart that showed me my marginal rate from now until my death. Hmmm, can I add to the chart my beneficiaries’ marginal rate? I’d be all set then.

With permission from, I’d like to offer the tax rate chart and a brief discussion of what marginal rate means and how you can use this knowledge to your benefit.


This chart shows the rate you’ll pay on different thresholds of taxable income. Not gross. This is an important distinction as there is both an exemption (currently $3650 per person) as well as a standard deduction (currently $11,400 for married filing joint, which is the status I am using for this exercise). So, for example, a married couple with only the standard deduction and two exemptions would be in the 15% bracket for a gross income up to $86,600. This is the sum of the $67,900 from the chart along with the standard deduction and exemptions. At retirement, to draw on your retirement accounts at an $86,600 annual pace would require approximately $2.2 million. This assumes a 4% withdrawal rate, the rate considered safe, at least until the recent market turmoil.

Roth IRA Amounts and Retirement Wealth

In a study by the AARP Public Policy Institute, How Will Boomers Fare at Retirement I find that for those born in 1956-65 the mean (half are above half below) expected household wealth is forecast to be $839K. This includes so-called “Social Security Wealth” as well as non-retirement wealth. When I look further, I find that “retirement wealth” to be projected as $503K, certainly not enough to put the mean retiree into a bracket above 15%.

With mean retirement wealth at barely over a half million dollars, yet two million needed to put you above the 15% bracket in retirement, why the excitement? Let’s dig a bit deeper. Here is a pretty recent chart showing the range of family income in 2007 dollars.


We can see that a family earning about $75,000 is in the 60% percentile for income and still the 15% bracket. Depending where this family is in their earning cycle, Roth may make sense for them, a couple early in their careers may find that they earn their way into the 25% bracket and spent much of their lives there, so having some Roth savings early on, while still in the 15% bracket, can’t hurt. This advice goes for any young person or couple getting started, not a bad idea to avoid the risk of higher rates in the future. Statistical data aside, for those individuals who have a robust pension plan at work and have a chance to replace their preretirement income and then some, should also strategically make Roth deposits. But some caution is in order. Remember how I talked about my lifetime marginal rate chart? For most of us, that line isn’t flat, straight, or without blips. Life happens. Jobs are lost, babies are born, and wives may choose to take a break from work. What do these things have in common? Periods of lower income in which one may drop back into the 15% marginal rate while being in the 25% bracket or higher prior to the disruption. This can be used to convert some Roth money to a traditional account, and pay only 15% to do so.

Let’s Take Another Look…

Let me offer one more way to look at this dilemma – if a couple were to retire today, 2009 tax rates, a combined standard deduction and exemptions total $18,700. I call this the ‘zero’ bracket amount as you could have this much gross income and still pay no tax. It would take $467K in retirement assets to generate this much in annual withdrawals (remember, I am using the 4% withdrawal rate). The next $16,700 is taxed at 10%, and this sum requires another $417K in retirement assets (up to $884K total). As I mention above, it would take $2.2 million in retirement assets to generate enough income to put you above the 25% bracket. These are today’s dollars, and will creep up as inflation raises both the standard deduction and exemptions.

Another factor many miss is that when you pass, your retirement accounts have required distributions for your non-spouse beneficiaries. If your children are in a high bracket, it may make sense to use the Roth conversion and pay the tax at your rate so the money they must withdraw has no further taxes due. This strategy can also be used to reduce you estate taxes if you are leaving a taxable estate.

To summarize:

While not impossible, it’s difficult to “save your way” into a higher bracket at retirement.

There will likely be periods of lower income during your life when conversions are appropriate. Take advantage of conversions during these times.

Look at your marginal rate, and be aware from year to year what tax bracket you fall into.

Spend some time to project what your retirement wealth and income will look like, this number will be fuzzier the further out you go, but at least start to make a projection.

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*Restrictions, penalties and taxes may apply.  Unless certain criteria is met, Roth IRA owners must be 59 1/2 or older and have held the IRA for 5 years before tax-free withdrawals are permitted.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Creative Commons License photo credit: quinn.anya

This is a guest post post from Joe author of the blog JoeTaxpayer.



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