In the old days, the decision to fund a retirement account with pre-tax dollars (traditional IRA) or fund it with after-tax dollars (Roth IRA) often hinged on when a person predicted his income would be highest and thus the tax savings greatest.

So, if a person thought his or her income was high now and would go down in retirement, then he might choose a traditional pre-tax retirement investment to save on taxes now.

If a person thought income would be higher in retirement, then he may choose an after-tax retirement account to pay tax now but avoid it later when tax rates could be higher.

Of course, either option offers an opportunity for tax savings. But the calculus has shifted in recent years and for me, the Roth is the clear winner in either scenario.

To continue with the “old days” analysis for a moment, let’s say you are a high wage earner. As such, you see value in reducing your taxable income by contributing to a traditional IRA or 401(k) assuming that you will make less money after you retire.

For the most financially successful individuals, this is often not the case as the earnings continue to accumulate and the now 65-year-old has amassed a fortune.

Sometimes, the later reflection on the decision to make pre-tax contributions results in a statement like this: “I wish I had paid taxes when I was younger and at a lower tax bracket than I am now.” So, I propose that even the predictions of tax savings aren’t well suited to the highest earning folks.

Three additional realities now push the decision to consider paying more tax now via contributions to Roth retirement accounts: the estate tax, the income taxation of retirement accounts to heirs and the SECURE Act (Setting Every Community Up for Retirement Enhancement Act) of 2019.

Estate tax impact

The Washington state estate tax is imposed on estates over $2.193 million.

Keep in mind, the “estate” is made up of all your assets including life insurance proceeds (life insurance is generally not subject to income tax but is subject to estate tax).

Because of the fact that many people carry hefty life insurance policies and the fact that Washington has not increased its estate tax exemption to keep pace with inflation, more Washingtonians are being subjected to the estate tax.

A pre-tax asset (like a traditional IRA) artificially increases the size of the estate and thus it can increase the estate tax exposure.

A Roth account, on the other hand, has already been taxed and thus reduces the amount of the estate subject to the estate tax and can even reduce the marginal tax bracket for the estate.

And, as Washington has the highest estate tax rates in the country, avoiding those higher brackets can be important.

As a reminder, the estate tax starts at 10% of assets above $2.193 million and can go as high as 20%. The problems are compounded for those where the IRA causes the estate to rise above the threshold for federally taxable estates and can incur taxes as high as 40%.

Note that an heir of an IRA may be able to claim an income tax deduction on their individual income tax return for estate taxes paid.

“Step-up” challenges

Not all assets are equally valuable to your heirs.

At present, all assets in your estate are entitled to a “step-up” in tax basis at death, except for retirement accounts.

Having a high tax basis is a good thing – it reduces the income tax attributable to the asset for your heirs.

For Roth retirement accounts, the lack of step-up in tax basis is irrelevant – distributions to heirs from Roth are tax free.

But, for the traditional IRA, it can be a significant and complex consideration for how best to distribute assets of your estate fairly to your heirs because those that receive more of the traditional IRA will pay more (maybe much more) in income tax than those that receive other assets.

Eroding benefits

In 2019, Congress passed the SECURE Act which eroded the benefits available to those who inherited a traditional IRA.

With limited exception, it curtailed the time under which the funds in a traditional IRA had to be withdrawn by the beneficiary. A byproduct of the quicker withdrawal rate is the reality of larger yearly distributions – which then mean higher marginal tax bracket exposure.

In general, all assets in a traditional IRA must be withdrawn within 10 years.

Before the SECURE Act, a beneficiary might be able to spread the withdrawals (and the related income tax) out for many decades.

By shortening the timeframe to 10 years, the SECURE Act increased the likelihood that the beneficiary will pay a higher marginal tax rate on the distributions. Here again, this penalty does not apply to Roth accounts.

High-balance traditional IRAs

Given the challenges presented by traditional IRAs, many people are finding alternative ways to utilize the funds.

Of course, a person can work to convert the traditional IRA over time to a Roth IRA.

The necessary result is that the conversion causes the amount converted to be included in taxable income for that year and thus increases the tax burden.

That additional tax burden can sometimes be offset with other tax planning strategies. Some people, recognizing the tax implications their heirs will encounter when inheriting traditional IRAs, are utilizing those assets for charitable purposes instead.

So, instead of giving 10% of the entire estate to a charity, they might instead direct the totality of just the IRA to charity.

A contribution like that would effectively eliminate the estate tax associated with the value of the IRA and the charity would not have to pay income tax on the amount withdrawn (a benefit of being a qualified charity).

Beau Ruff, a licensed attorney, is the director of planning at Cornerstone Wealth Strategies, a full-service independent investment management and financial planning firm in Kennewick.