Roth IRAs Turn 25 – A Retirement Savings Tool with a “SECURE” Future
By Jodie Norquist, CIP, CHSP
It’s been 25 years since Roth IRAs first became available as a tax-favored retirement savings option. Today, Roth IRAs are just as relevant as they were when they were introduced on January 1, 1998, created by the Taxpayer Relief Act of 1997. In fact, the SECURE 2.0 Act of 2022 includes provisions that may continue to expand the popularity of Roth IRAs as a unique retirement savings tool in years to come.
What Makes Roth IRAs Unique?
The late Senator William Roth, Jr. (R-Del.) advocated for this type of IRA. For his longstanding support of retirement savings initiatives, he was honored with having both the Roth IRA and, later, the Roth 401(k) named after him.
Traditional IRAs, which have been available since 1975, allow for tax-deductible contributions, but the distributions are not tax free. Roth IRAs changed the game. Roth contributions are made with after-tax dollars, so Roth IRA owners won’t receive a current-year tax benefit. The tradeoff is that Roth earnings grow tax free. When these Roth assets are later withdrawn (typically after the Roth IRA owner is age 59½) and the account has been opened for five years or more, the distribution is tax free and penalty free.
One huge advantage of Roth investing is that it provides a hedge against paying more tax in the future—either because your income in retirement is substantial or because tax rates increase. Think of this example: a student working part time includes her Roth IRA contribution in taxable income, but she’s in the lowest tax bracket. If she takes a qualified distribution at age 59½, she won’t pay any tax on her earnings, no matter what her current tax rate is. Roth IRA owners also don’t have to take required minimum distributions when they reach age 73 (as of 2023), unlike Traditional IRA owners, so they may be able to accumulate much more. What’s more, Roth IRA owners may distribute their annual contributions (not earnings) at any time without tax or penalty.
There are, however, income limitations for those who wish to contribute to a Roth IRA. So not everyone may be eligible to invest in a Roth IRA, unless they decide to do a Roth conversion.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) expanded the concept of after-tax retirement accounts by creating qualified Roth contribution programs in 401(k) plans, with rollover availability to Roth IRAs. The Pension Protection Act of 2006 (PPA) further expanded rollovers from other types of retirement plans to Roth IRAs, and income eligibility limits were indexed for Roth IRA contributions.
SECURE 2.0 Expands Roth’s Reach
The SECURE 2.0 Act includes several key provisions that allow more savers to invest after-tax dollars into a Roth account.
SEP and SIMPLE IRA Owners Can Now Make In-Plan Roth Contributions
While Roth 401(k) (and other deferral) programs are attractive to many plan participants, SEP and SIMPLE IRA owners have been unable to make Roth contributions within their retirement plans. This has now changed. Effective for 2023 and later taxable years, employers may allow employees to treat SEP or SIMPLE IRA employer contributions and elective deferrals as Roth contributions. Previously, only pretax contributions could have been made to SEP and SIMPLE IRAs. But keep this in mind: implementing this (and other) SECURE 2.0 changes may require additional guidance and programming. For example, it seems that we will have to wait for a “SIMPLE Roth IRA” document from the IRS (or clear alternatives) before financial organizations will be able to accept such contributions.
Retirement Plan Employer Contributions May Be Treated as Designated Roth Contributions
Effective for contributions made after December 29, 2022, employers may allow plan participants to treat employer matching and nonelective contributions to qualified retirement plans as designated Roth contributions. Qualified plans include 401(a) defined contribution (including 401(k)) plans, 403(b) plans, and governmental 457(b) plans. Employer contributions treated as designated Roth contributions must be 100 percent vested and are included in the participant’s gross income. This option is also available for matching contributions made on qualified student loan payments.
New Emergency Savings Accounts Linked to Defined Contribution Plans
Effective for 2024 and later plan years, employers may offer a pension-linked emergency savings account (PLESA) to non-highly compensated employees as part of their 401(k) plan, 403(b) plan, or governmental 457(b) plan. Participants may contribute up to $2,500 (or less if dictated by the plan.) These contributions are designated Roth contributions. This provision contains strict distribution and repayment rules.
No RMDs for Designated Roth Accounts
Similar to Roth IRAs, designated Roth account assets in 401(k), 403(b), and governmental 457(b) plans will no longer be subject to pre-death RMD rules. In other words, no RMDs are required for designated Roth account owners when they reach RMD age. Although this provision takes effect in 2024, participants who have their first RMD due in 2023 and choose to take it on or after January 1, 2024, must still include any designated Roth assets when calculating their 2023 RMD.
Certain Catch-up Salary Deferrals Must be Treated as Roth Contributions
Effective for 2024 and later taxable years, salary deferral contributions to 401(k), 403(b), and governmental 457(b) plans that are considered “catch-up” contributions must be made on a Roth basis for participants whose prior-year compensation from the sponsoring employer exceeds $145,000 (indexed). This provision doesn’t apply to so-called “special catch-up” contributions to 403(b) or governmental 457(b) plans.
529 Plan-to-Roth IRA Rollovers Are Now Allowed Under Certain Conditions
Effective for distributions occurring after December 31, 2023, 529 plan beneficiaries may roll over up to $35,000 (lifetime) from their 529 account to a Roth IRA under certain conditions. To be eligible to roll over funds to a Roth IRA, 1) the 529 account must have been in existence for 15 or more years, and 2) the funds to be rolled over must have been in the 529 account for at least five years. In addition, the 529 plan beneficiary must have earned income (similar to the Roth IRA eligibility requirements) in order to make a rollover contribution. The rollover amount in any given year cannot exceed the beneficiary’s IRA contribution limit, reduced by any IRA contributions previously made for the year.
The Future for Roth IRAs
Roth contributions to IRAs and employer-sponsored retirement plans have been extremely popular for 25 years. If SECURE 2.0 provisions tell us anything, it is that the Roth concept of saving for retirement is here to stay.
