Benjamin Franklin famously observed, “The only two things you can count on in life are death and taxes.” To which an unknown wag offered the sardonic and almost equally famous rejoinder, “That may be true, but at least death doesn't get worse every time Congress reconvenes.”

Let’s start by belaboring the obvious and note that high taxation makes it challenging to create and accumulate wealth. Sure, everyone should contribute a fair amount toward the functions of government, but even most patriotic Americans could feel just as patriotic while paying a whole lot less. Unfortunately, it is generally difficult to escape the long reach of the (tax) law; fortunately, however, there is one specific tax-reduction tool widely available to all U.S. taxpayers, namely, the Roth IRA and its kissing cousin, the Roth 401(k). 

The sales pitch for a Roth IRA is compelling: Money is contributed to the account on an after-tax basis, meaning that people do not get a current income-tax deduction for the contribution. But once the money is invested, it can go into almost any investment activity you please (subject to the limitations imposed by the custodian of the account) and all income earned from those investment activities—whether interest, dividends or capital gain—is excluded from current federal income tax (and typically state income tax) at both the IRA level and at the taxpayer level. Moreover, when it comes time to distribute funds from the Roth IRA in the future, these distributions are likewise fully exempt from federal (and usually state) income taxation. Thus, the Roth IRA allows taxpayers to enjoy a tax-free investment that earns a full market rate of return. All in all, a very sweet deal.

A Roth IRA (like the regular IRA) is generally limited to holding investments of a passive nature, and only a very limited amount of income each year can be derived from an activity characterized as trade or business (e.g., the IRA must earn less than $1,000 per year of taxable income from public limited partnerships or other active businesses or else the IRA must file a tax return and pay income tax). But this is an easy problem to avoid, and the opportunity to enjoy full market-rate investment returns on a tax-exempt basis is a major wealth-building opportunity.

Regular Vs. Roth IRAs—The Fascinating Mathematics
A Roth IRA is best understood by comparison to its older relative, the regular individual retirement account (regular IRA). The regular IRA was authorized in the early 1980s and originally allowed U.S. taxpayers to contribute $2,000 per year on a tax-deductible basis (the contribution limit in 2023 is now up to $6,500 for younger taxpayers and $7,500 for taxpayers over 50) into the retirement account, accrue and compound the investment return tax-free, and then make taxable (but penalty free) distributions to the account holder after the account holder reached age 59½.              

Distributions prior to age 59½ in 2023 are subject to a of 10% penalty for early withdrawal in addition to income taxation of the distribution. Note: Over time the Congress realized the political expediency of giving taxpayers penalty-free early access to their funds and developed a variety of “hardship” exceptions to the early withdrawal penalty.

The mathematics of a Roth IRA compared to a regular IRA is intriguing but relatively straight-forward; however, the ultimate decision on which is better turns your ability to predict your financial life path and your marginal income tax rates far into the future. In order words, very challenging. Or nearly impossible.

The first mathematical insight is that if income tax rates stay exactly the same over time, and if your investment return is the same whether the funds are in a regular IRA or a Roth IRA (a logical assumption, but discussed more fully below), then the net after-tax result of investing in a regular IRA versus a Roth IRA is exactly the same!

Example 1: Assume Taxpayer X is trying to decide whether to contribute money for 2023 into a regular IRA or a Roth IRA. Assume X expects to earn the exact same investment return over 10 years and that the funds in either account will exactly double in value. Assume (using round numbers so that the math easier) the income tax rate is exactly 40% in 2023 and remains at exactly 40% through 2033. Assume X is trying to decide whether to contribute $1666.67 into a regular IRA, or pay the 40% tax on $1666.67 and contribute the after-tax amount, or $1000, into a Roth IRA. Ten years later, the accounts double in value, giving X $3333.33 in the regular IRA and $2000 in the Roth IRA. If X then distributes the funds from each IRA, and pays 40% tax on the $3333.34 and no tax on the $2000, this means that X would have an after-tax return of $2000 from the regular IRA and $2000 from the Roth IRA—exactly the same outcome!

The blindingly obvious (in mathematical retrospect) conclusion is that if income tax rates stay exactly the same over time then contributions into a regular IRA and into a Roth IRA yield the exact same after-tax result! This is NOT what people intuitively understand or expect. But that epiphany then leads to some practical insights on appropriate investment strategies.

1)  If your marginal income-tax rate is higher today than you anticipate it will be in future year(s) when you expect to make IRA distributions, then a regular IRA is the better alternative. This might occur, for example, because you expect your tax bracket in your retirement years to be materially lower than in your highest earning years.

2)  Conversely, if you think your marginal income tax rate today is lower than in future years when you expect to make withdrawals, then a Roth IRA is the likely better alternative. This might occur, for example, because you plan to work full-time into your 70s and expect your income to stay high while federal and state income tax rates may also increase.

These “truisms” are in fact true, but also simplistic. Other material factors can also come into play. Let’s explore some these other factors further and then come back to the question of which IRA choice is better for you.

Mandatory Distributions And Estate Planning Issues
IRAs are structured to penalize you if you make early distributions (absent a permitted hardship purpose) before 59½ but they also have back-end rules that start pushing money out of the account when the federal government decides it is time. Required minimum distributions (RMDs) are the minimum amounts you must withdraw from your retirement accounts each year. You generally must start taking withdrawals from your regular IRA, SEP IRA, SIMPLE IRA, and other retirement plan accounts when you reach age 72 (73 if you reach age 72 after Dec. 31, 2022).

The RMD mandatory age has increased (due to politics) from 70½ to 73. (Stay tuned for further age increases as Congress seeks to ingratiate itself to the elderly owning sizeable retirement accounts.)

By contrast, Roth IRAs permit but do not require any withdrawals until after the death of the owner. Designated Roth accounts in a 401(k) or 403(b) plan are subject to the RMD rules for 2022 and 2023. However, for 2024 and later years, RMDs are no longer required from designated Roth accounts. (People must still take RMDs from designated Roth accounts for 2023, including those with a required beginning date of April 1, 2024.) Thus, an important and often overlooked benefit of a Roth IRA is that you are not subject to RMDs.

Estate planning further favors Roth IRAs immensely over regular IRAs. For inherited regular IRAs, the future distributions are classified as “income in respect of a decedent” and are both (1) includible as a taxable asset at nface value in the estate of the decedent and (2) will be taxable income when distributed to the beneficiary. Thanks to the 2020 Secure Act, regular IRAs left to a non-spouse must in addition be distributed within 10 years of inheritance. 

If parents die in their 80s leaving regular IRAs to children in their 50s, this 10-year RMD regime coincides with the peak earning years (and peak income-tax bracket years) of the children. Worst-case scenario occurs if the regular IRA triggers estate tax (with a paltry basis adjustment under Code Section 691) followed by a high-bracket income tax on most of the distribution amounts. The combined tax cost of this “double tax” can be as high as 70%. At estate tax seminars presented to knowledgeable estate planners, I generally recommend leaving regular IRAs to charities in order to avoid this hassle, and then (facetiously) comment, “You should only leave regular IRAs to your children as a prank.” Estate planners laugh appreciatively.

The general (non-spousal) 10-year RMD rule also applies to inherited Roth IRAs, but if the decedent satisfied the five-year rule prior to death then the withdrawals are tax-free. It makes a Roth IRA a better estate planning asset compared to a regular IRA, where taxes bunched into a 10-year post-death period  can substantially erode the value.

Will Tax Rates Increase?
Start with this simple question: What the heck is going to happen in the future with federal and state income tax rates? The answer is God only knows—and even God is hedging the bets.

On the one hand, it is easy to be aghast at federal government spending deficits and, the endless bloat of state and local government. and conclude that taxes must necessarily rise, and thus conclude that the Roth IRA is likely to produce a better end result over time.

But marginal income tax rates have a weird history. The maximum federal income tax rates at the end of World War II were as high as 90% (or more), and then were still at 70% in the 1970s. These tax rates spawned a huge tax-avoidance industry, enabled by an Internal Revenue Code that allowed aggressive tax shelters, and very few people actually paid taxes at the top rate. The marginal rate dropped to 50% in 1981 and then down to just 28% (briefly) in 1986 under President Reagan. At the same time, the vast majority of tax shelters were reduced and largely eliminated by the Reagan-era tax changes.

The peak rate soon bumped back up to 31% under President George H.W. Bush in 1990, then 39.6 % in the Clinton era, back down to 35% in the George W. Bush era, back up to 39.6% under Obama and down to 37% under Trump. Biden tried—unsuccessfully—to raise tax rates back up to 39.6%. For more than 30 years, the top marginal rate has remained in a relatively narrow band between 35% and 40%

Federal tax policy has been affected by the famous Laffer Curve and similar economic theories suggesting that maximum income tax rates do not produce maximum tax revenues, and everyone pretty much accepts this observation. Even taxaholic Senator Bernie Sanders has said he would not raise federal income rates to the 90% levels of the Eisenhower years. You might conclude, based on the history noted above, that federal income tax rates are going to have political resistance at any rate much above 39.6%—and that any future increase from current rates is not likely to be a quantum jump. An interesting conclusion to reach, if you reach it.

Meanwhile, at the state level, tax rate competition among jurisdictions has had a major impact, and many states now recognize that raising tax rates can lead to flight by high income individuals (and their businesses) and a net diminution in tax revenues. My home state, Massachusetts, succumbed in 2023 to tax populism when a ballot initiative raised the maximum tax rate to 9% on income above $1 million (and thereby welcomed back the state’s old nickname “Taxachusetts”), but almost every other state has been either stayed the same or actually cut taxes (over 20 states enacted tax reductions in the past two years, and only Taxachusetts raised taxes materially).

A high state income tax is easily dodged by moving elsewhere, and the ability to cut your state income in taxes from 12.4% (New York) and 13.3% (California) to zero may point toward funding a regular IRA coupled with a call to Mayflower Movers just before age 73 (when the mandatory required distributions for your IRA kick in).

Convert Regular IRAs To Roth IRAs In Your Down Years
Conventional wisdom and popular tax advice suggests converting your regular IRA (or your traditional 401K) into to a Roth investment in years when your income is down and your marginal tax rate is lower. I have used this technique, but it has limitations and caveats. 

Income tax brackets are stepped and there is only so much discretionary conversion income you can trigger before you are back near the maximum tax bracket. Remember, if your tax bracket is low and your future tax bracket is high, a Roth IRA clear comes out ahead. But if you can only convert $100,000 out of your $800,000 regular IRA before the tax brackets become indistinguishable, then the strategy has obvious ceilings and limits. It is probably worth doing so long as you are confident that the “down” year tax rate is likely to be materially lower than in your “retirement” year. That is not always easy to judge—but you make the call.

Do Regular IRAs And Roth IRAs Have The Same Investment Return?
An IRA account—whether regular or Roth—with the same investor and same investment advisors “ought” to have the same exact investment return over time. Except in my experience, they do not.

A regular IRA is an open invitation to take disproportionate and even wildly improbable risks. After all, about 40% or more of the money belongs to the government, and who really cares if you gamble big and lose their money? In gambler’s parlance it is like playing with the “house’s money.” Go wild.

A Roth IRA, by contrast and by definition, is all your money. It is after-tax money and if you lose it—ouch! You don’t even get a capital loss deduction. Also, all income from the investment is tax free forever. Given these factors, there is an irresistible urge to invest in high-yielding investments that (fakely) suggest your principal is safe and your interest/dividend return is tax-free and huge. In fact, Roth IRAs are often drawn to invest is high-yield, high-risk investments that have arguably as much risk as high-risk equity investments but without the stratospheric upside. When involved in investment decisions, I recommend investing both a Roth IRA and regular IRAs like any other investment account—look for a good, conventional return and be satisfied. Few people seem to welcome or follow that advice.

Joseph B. Darby III, Esq., is an adjunct professor at the Boston University School of Law and the founding shareholder of Joseph Darby Law PC, a law firm that concentrates on sophisticated tax and estate planning for individuals and businesses.