Who's Roth IRA to fund: my wife's or mine?

[SilverAg47]

My wife and I are 12 years different in age (I am older.) I'm in late 40's. Have funded my own 401k well for years. Wife does not have 401k. Now with 2 kids, we can't fund all 401k limit for me and do both her and my Roth IRA as well. What are questions I need to be asking to determine how to prioritize 401k, her Roth, and my Roth? Does 12 years difference help us because of when we would have to withdraw and thus it would be better to balance amounts over time? Thanks for any insights.

[Markbike528CBX]

I would fund the wife's Roth. The age difference gives a better chance for longer term tax free growth, This is assuming you won't need her Roth before she's 59-1/2.

[Systems101]

Mark:
ROTH does not have RMD requirement. So the husband can as well keep the money in his ROTH and get the longer tax-free growth advantage. Additionally, as far as I know, when a spouse inherits a ROTH, it can be treated the same as his/her own ROTH. In the spouse inheritance situation, I think the distributions are not subject to the early withdrawal penalty (i.e., can be withdrawal even if the spouse is under 59 1/2). If this is the case, what would be the advantage of preferring wife's ROTH? Is it for "forced discipline to preserve asset" (i.e., a forcing factor to ensure that wife has some asset left when she is 59 1/2)?

[Markbike528CBX]

System101 -
I am well aware a Roth does not require RMDs. My response was based on the age difference and the assumption he would pass first, plus that the money would not be needed prior to 59-1/2 (which I stated.) I'm no expert on the requirements, but I believe to avoid RMDs on the inherited Roth a spousal rollover to her own Roth is required. Its not a big thing, and I believe it can be set-up automatically provided she is the only beneficiary, but it is one less thing for her to worry about after her spouse's passing. If it is left as an inherited account, I believe RMDs may be required. I realize my recommendation was based on several assumptions and my rudimentary knowledge of the subject, but I'll stick to it for now. It's what I would personally do in the scenario presented. Of course I would also ensure that I had more than adequate fixed term life insurance to provide for the spouse plus the children until they become of age, which is also an unknown in this situation.

[RichMoose]

Breaking your problem into 2 parts:
 
1. Whose ROTH is better? ROTH IRA contributions are after-tax and the withdrawals are tax-free as long as the eligibility criteria is met. There is no RMD on ROTH, which means one can choose to keep the money in a ROTH as long as desired, and the money will grow. So between 2 ROTH accounts, the one that becomes eligible sooner seem to be the better choice. All else being equal, the older person's ROTH seems to be a better candidate - if fund is needed, it can be withdrawn sooner; if fund is not needed, it can be left as is to let grow.
 
2. 401K or ROTH? The choice here depends on employer contribution, current tax liability, future tax liability (at the time of withdrawal), years until distribution starts. If one is missing out employer's match, or is in a relatively high tax bracket, then 401K contribution will likely be better because of the extra money that goes into action immediately. If employer match is maxed out, and there is no meaningful additional tax burden, then ROTH will likely be better, especially due to the no-RMD feature.

[Ggnoob]

Just some additional thoughts:


A. Generally, in terms of using funds, Roth money should be withdrawn/used last.  Also, any Roth contributions can always be taken out without taxes or penalties. So, I am not sure it makes much of a practical difference which of the two Roth accounts gets funded.  The 59.5 age limit might be the tie-breaker as RichMoose suggests, but it might not make much of a difference. My understanding:
   


You will not be subject to the 10% TAX PENALTY on withdrawals of any CONTRIBUTIONS.  You will not be subject to the 10% TAX PENALTY on withdrawals of any conversions or rollovers if you meet a 5-year test on the specific conversion/rollover or if you are over 59.5 (or other qualifying circumstance).  You will not be subject to the 10% TAX PENALTY on withdrawal of EARNINGS if you are over 59.5 (or have another qualifying circumstance).
 

Contributions and Rollover/Conversion amounts in a Roth are not subject to income tax (they were already paid, for example when the conversion took place).  Earnings will not be subject to income tax if you are over 59.5 (or have another qualifying circumstance) and have had ANY Roth open at least 5-years (i.e., meeting the 5-year test).


Memo: If you are under 59.5, EARNINGS are not subject to the 10% TAX PENALTY or INCOME TAX if used under a specific qualifying circumstance (e.g., under a higher education exception or under the $10 k first-time home buyer exception).

Your earnings are withdrawn last, after withdrawal of funds from contributions, rollovers, and conversions.

B. The 401k should be funded at least to get any match. Assuming that additional 401k contributions are BEFORE TAX, then it may then come down to tax rates. Note that Required Minimum Distributions may cause higher tax rates, so should be reflected in the future tax rate assumptions. Also, a surviving spouse may be in a higher single bracket.

Say, I have $1000 that I could now put in the 401k.  

1.  Assume my tax rate now is 24% and my tax rate later is 12%. 

Case 1-a)  I put the $1000 in the 401k, and it doubles over time. Then I have $2000 later. After 12% tax, I get $1760.

Case 1- b) I instead decide to put the $1000 after 24% tax equivalent of $760 into a Roth and it doubles over time. Then I have  $1520 later after no further tax.

So, in this tax rate scenario (lower rates later), it is better to fund the 401k.

2. Assume my tax rate now is 12% and my tax rate later is 24%.

Case 2-a)  I put the $1000 in the 401k, and it doubles over time. Then I have $2000 later. After 24% tax, I get $1520.

Case 2- b) I instead decide to put the $1000 after 12% tax equivalent of $880 into a Roth and it doubles over time. Then I have  $1760 after no further tax.

So, in this tax rate scenario (higher rates later), it is better to fund the Roth.

3. Assume my tax rate now is 24% and my tax rate later is the same 24%.

Case 3-a)  I put the $1000 in the 401k, and it doubles over time. Then I have $2000 later. After 24% tax, I get $1520.

Case 3- b) I instead decide to put the $1000 after 24% tax equivalent of $760 into a Roth and it doubles over time. Then I have  $1520 after no further tax.

So, in this tax rate scenario (same rates later), it makes no difference whether to fund the 401k or Roth.

However, for break-even, I probably would be inclined to go with the 401k and avoid the sure tax cost now.

[Abe]

I am six years older than my wife. I always fully fund her Roth before I add to mine. I am retired, and she is still working, but that would not change my reasoning for funding her first regardless of our circumstances. I already have a larger ROTH than she does, and I want to make certain that she doesn't have to deal with any peculiarities or tax law changes that might come about when she might inherit any of the accounts in my name. I'd like to keep complications to a minimum because investing and managing accounts is not her first love.

[Azdude]

I am six years older than my wife. I always fully fund her Roth before I add to mine. I am retired, and she is still working, but that would not change my reasoning for funding her first regardless of our circumstances. I already have a larger ROTH than she does, and I want to make certain that she doesn't have to deal with any peculiarities or tax law changes that might come about when she might inherit any of the accounts in my name. I'd like to keep complications to a minimum because investing and managing accounts is not her first love.

Thanks for the note. In another post, someone noted a reverse strategy in that our Roth's will be available for withdrawal without penalty 6 or 12 years earlier, and so given there is no required withdrawal, this was the money could be tapped more quickly anytime needed, but without required tapping. That makes sense to me. So you main point is simply that by putting into her' Roth, you know you won't ever have to deal with any unforeseen changes to inheritance laws? I certainly get that as a motive.

[Abe]

Yes, I know the Federal government can and does change the rules from time-to-time and not always to my liking. With that in mind, having her account more robust makes sense to me. In addition, it would be our goal to avoid using the dollars in the ROTH unless we wanted to do a withdrawal that did not impact our tax situation. Our income taxes, with the RMD I expect to see from my traditional IRA, could be significant.  So fully-funding my wife's ROTH and my ROTH is still the strategy.
 
Regarding ROTH withdrawals to minimize taxes: Our oldest granddaughter, now 14, asked us yesterday if we would consider taking each of our grandchildren on a trip "anywhere in the world" when they graduate from high school. I liked her idea, as did my wife. That motivates me to move even more of my traditional IRA assets into my ROTH IRA. She would like to go to New Zealand. My wife and I would as well. I would probably use my required RMD, because I will be 70.5 by the time this granddaughter graduates. That keeps my wife's Roth whole.

[stoaX]

A couple of non-tax rate items to consider.

One, an employer 401K sometimes has fewer investment choices where an individual IRA will have more. If looking for the next Amazon or Apple is your cup of tea, then limited options of mutual funds in a typical 401K will not be as much fun for you. You should also consider fees around each option.
 
Second, you can contribute to the ROTH until April 15 of the following year. So if you get a bonus, windfall, large tax return, or have cash on hand, you can contribute for the prior year at that point. I’ve always waited until my tax return was complete to fund my ROTH because you absolutely do not want to over-fund if you are near or over the income limits.
 
My vote...do both, as much as possible, with the 401K contribution to get the maximum match first. You’ll have more options when you hit the red zone and beyond.