Happy 20th Birthday, Roth IRA!

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1 Motley Fool s Rule Your Retirement Newsletter Happy 20th Birthday, Roth IRA! Robert Brokamp, CFP January 19, 2018 In 1998, Bill Clinton was president, the Dow Jones Industrial Average surpassed 9,000 for the first time, Titanic won the Oscar for the best picture, and John Elway led the Denver Broncos to victory over Brett Favre and the Green Bay Packers in the Super Bowl. That was also the first year investors could open a Roth IRA. Yes, this year marks the 20 th anniversary of the retirement account that allows investments to grow tax-free (as long as you follow the rules). Let's take a saunter down memory lane and learn about the genesis of the Roth (including the story behind its namesake) and why this year it's particularly important to consider whether a Roth is right for you. A Brief History of the Roth Before there was the Roth, there was the original traditional IRA. It was created by the Employment Retirement Income Security Act of 1974 (ERISA), a landmark law that put into place many protections that still govern the retirement-account and pension landscape. However, in their first incarnation, IRAs were only available to workers who weren't covered by an employer-sponsored plan. That changed in 1981 with the passage of the Economic Recovery Act of 1981, which also came to be known as the "Kemp-Roth Tax Cut" thanks to the bill's two sponsors: New York Representative Jack Kemp and Delaware Senator William "Bill" Roth. Among many other things, the bill lowered the rate on the top tax bracket from 70% to 50%. It also made IRAs available to anyone younger than 70 ½ who earned income. Retirement security was a longtime legislative priority for Roth, who grew up in Montana during the Great Depression. Legend has it, he became

2 interested in politics because he wasn't good at sports, so he spent his free time hiking to the capital and watching the legislators in action. He served on the staff of Douglas MacArthur during World War II, and then attended Harvard for both business and law school with help from the G.l. Bill. He moved to Delaware in 1954, and was elected to Congress in He was a mild-mannered politician, known more for campaigning with a St. Bernard at his side than for his rousing speeches. Roth was a fiscal conservative who became well-known in the 1980s for leading investigations into wasteful spending at the Pentagon. Remember those $640 toilet seats and $9,600 wrenches? You can thank Roth for bringing them to light (and getting government contractors to lower their prices, at least in the case of the toilet seat). He first proposed a tax-free IRA in 1989, which was then called the "IRA Plus." But it didn't become law until the Taxpayer Relief Act of 1997, which allowed for Roth IRAs to be opened the following year. Though Roth was a Republican, it was a Democrat's idea to name the IRA after him. According to Roth's wife, Jane, New York Senator Patrick Moynihan said, "This was Bill Roth's idea; we ought to call it the 'Roth IRA.'" (Jane Roth is accomplished in her own right. At age 82, she is still a judge on the U.S. Court of Appeals for the Third Circuit, and was inducted into the Hall of Fame of Delaware Women in 2013.) Unfortunately for Roth, having the new account named after him didn't prevent his being voted out of office in He died in 2003, three years before the Roth 401(k) and Roth 403(b) became available. Soon after his death, then-senator Joe Biden, who served with Roth in the Senate for 28 years, said that Roth was "the person I trusted most in my public life." Why the Roth Deserves a Fresh Look in 2018 While tax-free withdrawals are appealing, they come at the cost of higher taxes today since contributions to a Roth account don't reduce your taxable income. So you're essentially giving up a tax break now for a tax break in the future.

3 The new tax law that takes effect this year will result in lower taxes for most Americans, so a tax break today isn't worth as much as it used to be. It might make sense to bite the tax bullet this year in order to enjoy that sweet, sweet tax-free income in retirement. If that isn't enough to convince you to consider a Roth, consider these other benefits: Contributions (not earnings) to Roth IRAs can be withdrawn any time, tax- and penalty-free, even if you're not yet 59 1/2. That's handy if you plan to retire early, need money to pay for college, or experience a true emergency. (Note that early withdrawals from a Roth 401(k) may be messier; a portion will be tax- and penalty-free, but a portion may not receive such favorable treatment.) With a traditional IRA, once you reach age 70 ½, you can no longer contribute to the account; in fact, you must begin taking money out via so-called required minimum distributions (RMDs). Not so with the Roth IRA: Anyone of any age with earned income can contribute, and there are no RMDs. A Roth 401(k) is subject to RMDs, but you can get around them by simply transferring the money to a Roth IRA. The tax-free status of withdrawals passes to your heirs. Nothing says, "I love you" like a tax-free inheritance. (Note: We're not saying that this is the best way to say, "I love you." Just another way.) How to Get More Roth Assets There are three main ways to increase the amount you have in Roth accounts: Contribute to a Roth IRA. The limit in 2017 and 2018 is $5,500, with an additional $1,000 if you're 50 or older. We mention 2017 because you have until April 17, 2018, to make a contribution for Unfortunately, the ability to contribute to a Roth IRA is subject to income limitations, which change every year. Here are the limits for 2017 and for If you make too much money, you still might be able to fund a Roth IRA using the backdoor strategy.

4 Contribute to a Roth 401(k)/403(b). The limit for 2018 is $18,500, with an additional $6,000 if you're 50 or older. We don't mention 2017 because contributions to 401(k)s and 403(b)s must be made in the same calendar year. Fortunately, there are no income restrictions on contributing to an employersponsored Roth account. Convert traditional assets to Roth assets. You can turn all or a portion of the money you have in traditional tax-deferred accounts into tax-free Roth accounts. Just know that the amount you convert will be added to your taxable income in the year of the conversion. Also, thanks to the new tax law, the ability to "recharacterize" a conversion essentially, change your mind has been eliminated. So be 100% sure you want to convert before calling your broker. Get Some Tax Diversification The large majority of retirement assets are in traditional tax-deferred accounts. According to the Investment Company Institute, only one-third of IRA accounts are Roths. Then there are the assets that investors hold in regular, taxable brokerage accounts. When investors make withdrawals from these traditional IRAs and brokerage accounts in retirement, there's a good chance there will be tax consequences. As IRA expert Ed Slott often points out, you're not the sole owner of these accounts. You have a co-owner: Uncle Sam. Not so with the Roth; all the money is yours. Having assets in Roth accounts provides "tax diversification," and enables you to have more control over your tax bill in retirement by allowing you to tap different accounts in different years, depending on your situation. Earlier this month, Slott Tweeted: "I look at a Roth IRA as tax insurance. Once you pay in, you're protected against future tax hikes." Given that rates have dropped to historic lows and government deficits are on the rise, it's perfectly reasonable to expect higher tax rates in the future. To be sure, contributing to a traditional IRA or 401(k) still makes sense, especially if you're in a high tax bracket and you invest the money that

5 you save on your tax bill (in other words, the tax break allows you to save more). But if you're in a middle to lower tax bracket, or if you just spend the money you saved on your tax bill by contributing to a traditional account, a Roth account is well worth considering.