The Most Overlooked Phase of Roth Planning

Early in my career, a more seasoned financial planner told me, “Clients just don’t spend their Roth IRAs. It’s a fact.”

I remember pausing at that. Is it that investors don’t want to spend their Roth IRAs, or is it that we, as planners, haven’t done a great job demonstrating when it makes sense to do so?

Somewhere along the way, not spending Roth assets has become an erroneously unspoken rule. But a Roth IRA is one of the most flexible assets an investor can have in their toolkit; it grows after-tax, is not subject to Required Minimum Distributions, and can ultimately be withdrawn tax-free.

We spend a great deal of time determining whether it makes sense to fund a Roth based on a future in which an investor’s tax rate may be higher. And yet, if those dollars are never ultimately used, did we miss the most important phase of the planning arc? And when we think just through the lens of income tax forecasting, we fail to pay attention to the interplay of income and other sneaky costs, like healthcare premiums.

For those retiring prior to Medicare age, health insurance is often sourced through the marketplace where premiums are directly tied to Modified Adjusted Gross Income (MAGI). With the recent expiration of enhanced subsidies, managing MAGI is more important than ever. Distributions from pre-tax accounts add to this MAGI number and can push monthly healthcare premiums to levels rivaling the cost of mortgage or rent. Roth distributions, however, do not impact MAGI. With thoughtful multi-year planning and cashflow projection analysis, creating a Roth drawdown strategy can be a powerful solution in minimizing taxable income, and thus keeping healthcare costs significantly lower during these transition years in retirement.

A similar pattern may repeat itself later in retirement, starting at age 63. Medicare premiums are based on MAGI from two years prior. In a year with unusually high income—perhaps due to the sale of property at a large capital gain— even one additional dollar of income can bump a retiree into a higher Medicare premium tier. In some cases, these premium increases are not insignificant. Having Roth assets available to draw on creates optionality; instead of turning to tax-deferred or taxable accounts for monthly expenses, utilizing Roth assets can meet spending needs without compounding the Medicare premium issue.

Of course, there are also scenarios where preserving the Roth IRA is most appropriate. It is often viewed as a powerful legacy asset, and in the right circumstances, it can be. But even here, assumptions can lead to less-than-optimal tax planning and decision-making. It is easy to assume beneficiaries will be in higher tax brackets during their working years in which they may inherit the account, but a retiree couple with Social Security benefits, pensions, Required Minimum Distributions, and taxable dividend income may find themselves in a higher tax bracket than their adult children. Without running an income tax analysis, it is difficult to know which path is truly more advantageous; do we spend the Roth now? Or, save it for the next generation?

The bottom line? Our objective should not be to avoid spending Roth assets, nor to preserve them at all costs. Instead, a Roth IRA should be used in coordination with the rest of the financial plan. Ultimately, decisions around when to draw from pre-tax accounts, when to incorporate Roth dollars, and when to preserve assets for legacy planning should all be made in the greater context of an investor’s income, tax exposure, healthcare costs, and other life goals and aspirations.

This material is intended for educational purposes only. You should always consult a financial, tax, or legal professional familiar with your unique circumstances before making any financial decisions. Nothing in this material constitutes a solicitation for the sale or purchase of any securities. Any mentioned rates of return are historical or hypothetical in nature and are not a guarantee of future returns. Past performance does not guarantee future performance. Future returns may be lower or higher. Investments involve risk. Investment values will fluctuate with market conditions, and security positions, when sold, may be worth less or more than their original cost. Advisory Services offered through Avise Financial Cooperative Inc, a Registered Investment Adviser with the SEC. Registration of an investment adviser does not imply a certain level of skill or training.