The CNBC article makes the case the Biden tax plan will make Roth accounts more desirable than conventional accounts. The article understates the benefits from choosing Roth over conventional accounts, which pre-date the Biden administration.
The article states that Roth accounts are generally more desirable than conventional accounts if you expect your marginal tax rate to be lower in retirement than during working years.
Actually, the decision between Roth and conventional accounts largely determines your tax bracket in retirement. Roth distributions are not part of your taxable income. People with other income, an annuity, interest, dividend or capital gain income, and wage income for a part-time job or from a spouse can keep their income and tax bracket down if they have funds in a Roth account rather than a conventional account. The advantage of Roth over conventional accounts during retirement is not just that distributions from the Roth are untaxed but also that distributions from Roth reduce the taxpayers marginal and average tax rates.
The article points out that distributions from Roth rather than conventional accounts will reduce the amount of Social Security that is taxable income for taxpayers with income above a particular threshold. This is also huge because the exclusion of both the Roth distribution and the Social Security benefit from taxable income both reduces tax and taxable income and moves the taxpayer into a lower tax bracket, thereby, reducing marginal and average tax rates.
The exclusion of contributions to conventional accounts from current-year taxable income is a key benefit of conventional retirement accounts. However, there are many other ways to reduce taxable income and tax during working years, including, contributions to health savings accounts, newly enacted child tax credits, and deductions on mortgage interest and other housing deductions.
Many people with scarce funds and medical expenses should choose contributing to a health savings account over contributing to a 401(k) if they have a high-deductible health plan. Health savings accounts and conventional retirement accounts are highly substitutable because both reduce current year taxable income and excess funds in health savings accounts can be used for non-health purposes in retirement. People who lower their marginal tax rate by contributing to health savings accounts or through other means should place whatever funds they have remaining in a Roth rather than a conventional retirement account, especially if their tax reduction strategy was successful.
A lot of working-age people pay no or very little income tax. But for some reason, financial advisors really like to push the tax advantages in working years associated with contributions to conventional retirement accounts. This decision can be extremely costly in retirement years. Household with a disproportionate amount of wealth in a retirement account, who also have mortgage debt, must distribute funds to pay the debt and funds to pay tax on the distribution to pay the debt.
The article mentions the new tax provision discussed here that requires many people with inherited IRAs to make distributions within 10 years. This tax change was enacted in 2019 prior to the Biden presidency. Heirs of a conventional account will pay tax, at the ordinary income tax rate, on these distributions. This could be quite painful if distributions are forced during peak-income years. Heirs of Roth accounts will not pay tax on these distributions. Do your heir a favor and convert your traditional accounts to Roth account before you die.
The CNBC article states that lower estate tax thresholds proposed by Biden will cause Roth conversion. Perhaps. But there are already a lot of reasons to convert and even if the Biden administration succeeds in getting a sizeable expansion in the base subject to the estate tax most wealth in households impacted by the estate tax will not be associated with retirement accounts.
Roth accounts are for most people the better choice. Not a close call. This has been the case for quite some time. The horse is out of the barn.