Why Older Americans Should Get Hip to the Roth IRA

The generation gap has a new frontier: IRAs. The older you are the more likely you are to favor a traditional IRA over a Roth IRA, new research shows. Things evolved that way for good reason. But it may make sense for older investors to step back and consider what the youngsters are up to.

Nearly a third of Roth IRA investors are younger then 40, compared to just 15% of traditional IRA investors, the Investment Company Institute found. Meanwhile, only 24% of Roth IRA investors are older than 60, compared to 39% of traditional IRA investors. The ICI examined IRA account data from 2007-2014.

The skewed distribution developed naturally. Roth IRAs have income eligibility limits for contributions while traditional IRAs do not, though there are limits on deductibility. So the Roth has long appealed to younger, typically lower-paid workers. Traditional IRAs have been around much longer, and retirees often roll assets from their 401(k) plans into a traditional IRA—rollover money accounts for the largest share of growth in IRAs.

But just because we got here naturally does not mean older investors should steer clear of Roth IRAs. The two are very different investment accounts, and the Roth provides valuable flexibility at any age.

A Roth IRA is funded with after-tax dollars. The money grows tax-free and qualified distributions after age 59½ are also tax-free. A traditional IRA is funded with pre-tax dollars. You usually get an immediate tax deduction and the money grows tax-deferred. Distributions after age 59½ are taxable as ordinary income.

In general, you want to shelter assets in a Roth if you expect your tax rate to be higher in retirement than it is now. That is another reason young people with low salaries and in a low tax bracket opt for them. You typically want assets in a traditional IRA if you expect your tax rate to fall in retirement. That is the case for most people when they quit working.

You are not eligible to contribute to a Roth as a couple if household income exceeds $194,000. For singles, the cutoff is $132,000. In both cases contributions begin to phase out at slightly lower income levels. Still, even high earners can get into a Roth by converting assets from a traditional IRA—even if that IRA was only recently opened. Since 2010, there have been no income limits on who is eligible to convert to a Roth.

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A conversion triggers an immediate tax bill. You will owe ordinary income tax on the amount you convert. Most planners recommend against converting if you must use converted funds to pay the tax. A good time to consider a conversion is in a year when your income is down, and you can convert at a lower tax rate, or when your investments have suffered losses, which would reduce your tax bill.

Why convert? It is not a given that your tax rate will go down in retirement. Tax laws are in constant flux. By socking away some money in a Roth you don’t have as much to worry about. A Roth conversion is also a valuable estate-planning tool. You are not required to take distributions in your lifetime. If you will not need the money, you can let assets grow longer tax-free.

We arrived at the IRA generation gap naturally. And like a Fade haircut, the Roth won’t look good on many older investors. But others will wear it well—and should take a second look.