The following is a book review of "ROTHS FOR THE RICH: How to Fund Your Roth With Over $100,000 Each Year," by Will Duffy, who responds to this article here.

Roth IRAs have long been a viable tax planning tool for advisors working with affluent clients. The prospect of higher taxes on high-earning Americans, coupled with the death of stretch IRAs, has rekindled interest in these vehicles. In his recently published book, "ROTHS FOR THE RICH: How to Fund Your Roth With Over $100,000 Each Year,"  Will Duffy aggressively advocates this strategy. 

Mr. Duffy argues that investing in Roth IRAs is far superior to investing in taxable IRAs. Throughout the book he compares a 40-year-old couple investing $55,000 each year, until age 65, in a Roth IRA (either directly or indirectly) versus the same couple investing $55,000 each year, until age 65, in a regular IRA. The purpose of this book review is to investigate three important areas which the book does not appear to address (at least sufficiently), but which are nevertheless crucial in conducting a regular IRA versus Roth IRA investment analysis.

What happens with the funds not invested in the regular or Roth IRA?
Using the main example in this book, this investor obviously has $110,000 of surplus taxable income lying around each year. This is because $55,000 will be invested in the Roth IRA and $55,000 will be paid to the IRS and state taxing authorities, based on the author's assumption that 50% federal income tax rates are on the near horizon. (A 50% combined federal and state income tax rate on income in excess of $400,000 a year won't be that unlikely by the year 2026, if not sooner under a Biden presidency, at least on designated types of income.)

The author illustrates that, at age 90, the couple’s Roth IRA will be worth approximately $29.7 million (apparently because the couple will never withdraw any of the funds for living purposes), while the regular IRA owner would net about $19.2 million (apparently assuming RMDs beginning at age 70-1/2), after factoring in income taxes on the required minimum distributions and on the reinvested after-tax RMDs, apparently at a 50% tax rate for all income, for a $10.5 million net advantage in favor of investing in Roth IRAs over regular IRAs.

If we assume the couple's other assets (i.e., home and/or other savings) are worth $2 million, at age 90 the couple would have $31.7 million in the Roth example and $21.2 million in the regular IRA example—again, based upon the apparent assumption that the owner uses none of the regular or Roth IRA funds to live on. If we further assume today's approximately $11.5 federal estate tax exemption, today's 40% federal estate tax rate and no state estate tax, the couple’s family would owe a minimum of $3.5 million in federal estate taxes in the Roth example, and $0 in federal estate taxes in the regular IRA example.  [Of course, estate tax exemptions are likely to decrease in the future (on a relative basis), so even if the couple spends half the regular or Roth IRA funds during their lifetime, and estate tax exemptions are eventually cut in half, there would still be significant federal estate taxes to pay in the author's Roth IRA example, though likely none in the regular IRA example.]

Assuming the 50% income tax rate which the author feels is coming by the year 2026 (if not earlier, after the election), in the regular IRA example the clients would have another $27,500 to invest each year, outside of their regular IRA, as the tax savings generated by the $55,000 tax deduction. In contrast, the Roth IRA investor would have given the entire remaining $55,000 to the IRS each year, in taxes, and would therefore be left with nothing else to invest, outside of their Roth IRA.  What happens to this annual $27,500 income tax savings?  According to the author, this savings “doesn’t exist anymore,” apparently because no one ever keeps track of it.  But just for fun, I decided to keep track of it.

Compounded monthly at the author's assumed rate of 8%, for 25 years (i.e., until the couple’s retirement age 65), the $27,500 annual tax savings would grow to $2,179,439.  Compounded monthly at 8% for an additional 25 years, or until age 90, this $2,179,439 would grow to approximately $15 million! Thus, rather than there being a $10.5 million advantage in favor of the Roth IRA approach over the regular IRA approach (assuming all income is taxed at 50%), there is actually a $4.5 million advantage in favor of the regular IRA approach over the Roth IRA approach—at the couple’s age 90—assuming no taxes on the annually invested tax savings.

Now assume that the couple pays federal tax of 10% each year on the reinvested after-tax RMDs (i.e., based on qualified dividends and harvested capital gains, and not on the portion of the after-tax RMDs reinvested in tax-free reinvestments, including cash value life insurance). This would mean that their 8% gross annual return would be reduced to 7.2%, and the value of the couple’s non-IRA account at age 90 would be reduced to approximately $11 million—still an approximately $500,000 advantage of the regular IRA investment approach over the Roth IRA investment approach. Remember too that, under existing law at least, the couple’s family would receive a stepped-up income tax basis on all of the couple’s taxable investments outside of the regular IRA at death, thereby effectively eliminating income taxes on the remaining built-in capital gain at death. 

What is more, although a full discussion of the topic is beyond the scope of this book review, if estate taxes are a concern for the couple, all or a portion of the $27,500 annual advantage of the regular IRA approach over the Roth approach, plus the after-tax RMDs the couple begins receiving at age 72, could be invested (in taxable and/or non-taxable investments) inside of a so-called "spousal access trust," which would provide spousal access to the trust's income and principal without the estate tax concerns. This significant additional estate tax advantage associated with the regular IRA investment plan would not be available under the Roth IRA investment plan, at least as the plan is promoted by the author.

If the couple only has $76,500 in surplus pre-tax funds to invest each year, and is not able (easily, at least) to invest the full $55,000 in a regular 401K plan (including a solo 401K plan), they might instead choose to invest $12,000 each year in a regular IRA and invest the balance (i.e., after 50% income taxes) or $32,250, in other investments which do not throw off significant current income, including income tax-free cash value life insurance.

Is a 50% tax on all income at retirement a realistic tax rate?
The author assumes RMDs will be withdrawn and reinvested by the IRA account holder at the maximum federal income tax rate each year. Especially given (i) the demise of the corporate pension plan, (ii) the fact that federal tax brackets are annually adjusted for changes in the “chained CPI” rate, and (iii) the fact that most of the couple’s income will probably not be subject to tax until actually distributed (as RMDs or otherwise) from the taxable IRA or until capital gains are actually recognized in the couple’s taxable account, a more realistic assumption should be that the retired investor will be taxed at a much lower rate than 50%. If this hypothesis is correct, and utilizing the author’s example, the above-described minimum $500,000 advantage which the regular IRA investment approach already has over the Roth IRA investment approach would actually turn out to be a much greater advantage.

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