Last Week’s Question of the Week: How many widows and widowers are currently collecting Social Security Survivors Benefits? ANSWER: There are about 5 million widows and widowers receiving monthly Social Security benefits based on their deceased spouse’s earnings record.
HOST: Today’s discussion revolves around if it makes sense to be putting money into a Roth IRA and Roth 401k vs. a traditional one and whether this is the best place to store your retirement savings?
KLAAS FINANCIAL: So first let’s establish what is different about a Roth IRA and Traditional IRA. A Roth IRA is a special retirement account that you fund with post-tax income There is no up-front tax deduction for Roth IRA contributions, as there is with a traditional IRA. And they have the same limits as traditional IRA’s, $5500 for under 50, and $6500 for over 50 for earned income per year. So again, remember you do pay taxes now. If you earn less than the maximum contribution limit, you can contribute only as much as you earned. If, for example, you earned just $3,000, you could contribute only $3,000 to a Roth IRA for the year. Non-working spouses can contribute the maximum amount to a Roth IRA as long as the working spouse earns enough to cover the contributions to both accounts and the household income doesn’t exceed the IRS income-eligibility limits.
The income limits for 2018 Roth IRA contributions depend on your tax filing status and how much your modified adjusted gross income is. If you are single, or head of household, your contributions are allowed with income under $120k, and phased out between $120k-$135k; Married filing jointly, contributions are allowed with income under $189k, and phased out between $189k-$199k.
HOST: So, what are the real benefits of owning a Roth IRA or Roth 401k?
KLAAS FINANCIAL: Roth distributions are tax-free when you follow the rules. And because every penny you stash in a Roth IRA is YOUR money—not a tax-subsidized gift from Uncle Sam—you can tap your contributions (but not your earnings on those contributions) at any time, tax-free and penalty-free.
The benefit of a Roth IRA all depends on the beholder’s tax bracket—both now and when he or she retires. Roth IRAs make the most sense if you expect your tax rate to be higher during retirement than your current rate. Bottom line: It takes tax uncertainty out of the equation because Roth IRA contributions are taxed up front, whereas traditional IRA contributions are tax-deductible.
Roth IRAs are ideal savings vehicles for young, lower-income workers who won’t miss the upfront tax deduction and will benefit from decades of tax-free, compounded growth.
HOST: What about ROTH 401ks available to me at work? Are the returns better than in a traditional 401k?
KLAAS FINANCIAL: So, for many of our listeners, you may have a choice in your retirement plans to choose a Roth 401k option. Again, which choice is better? The initial returns will not be different, but how it reflects today in your taxable income can be a factor.
- There are no income limits when contributing to a Roth 401k, whereas we do have those with the Roth IRA contributions.
- The maximum that you can put in total between a traditional 401k and Roth 401k is $18,500 or $24,500 if you are over 50. Some people will put 100% in one plan, or maybe 50% into one plan and 50% into the other, again depending on taxation and perhaps age considerations
- When you retire you will simply roll the Roth 401k into a Roth IRA. If you don’t, an existing Roth 401k will require RMD’s at 70 ½.
HOST: What about Roth Conversions? What are those?
KLAAS FINANCIAL: A conversion is actually that you are choosing to pay taxes due today (according to your current tax bracket)on the IRA, and then placing it into a ROTH IRA, where taxes will never be owed again .Sometimes this is referred to a “backdoor Roth”.
Why is it called a backdoor? Simply because maybe your income was too high to qualify to add money to a Roth IRA on the way in; but at any time you can convert money from the traditional IRA to a Roth IRA, with no restrictions to income.
Keep in mind: This isn’t a tax dodge. You will need to pay taxes on any money in your Traditional IRA that hasn’t already been taxed. The funds that you convert to a Roth IRA will most likely count as income, which could kick you into a higher tax bracket in the year you do the conversion.
On the other hand, if your income happens to be unusually low in a particular year—perhaps you had a gap in employment—you could take advantage of that situation by making the Roth conversion then.
Timing is important. Carefully calculate the tax implications of a Roth IRA conversion before you decide. Speak with your accountant.
HOST: Is there an age limit on completing a conversion from your IRA to a Roth IRA? Can I do it when I’m 70 or 75?
KLAAS FINANCIAL: There’s no age limit for doing a Roth conversion. So yes, you could complete one at age 70 or 75. You could do one at age 90 if you like. Perhaps you are looking to leave money to heirs, this could make sense. Again, looking at current and future income tax brackets is really the reason you might do this.
HOST: What happens if you inherit a Traditional or Roth IRA?
KLAAS FINANCIAL: In terms of estate planning, Roth IRA’s may be a solution for those who want to leave assets to their heirs tax-free. (Unlike Traditional IRAs, there are no required minimum distributions on Roth IRAs, so well-funded retirees can leave their Roth money untouched if they don’t need it.)
If you are the surviving spouse, you may have the option to delay withdrawals from a Traditional IRA to a later date by transferring the account to your name. If you aren’t yet 70½, the money can stay in your account until you are required to take minimum distributions. Meanwhile, if you inherit a Roth IRA from your spouse, you have the option not to take withdrawals during your lifetime.
The rules are more complicated for non-spouse beneficiaries, such as children and grandchildren. Whether it’s a Traditional or Roth IRA, you have to start taking distributions by December 31 of the year after inheriting. But you can choose to receive the money gradually using a distribution schedule based on your life expectancy. This is known as the stretch IRA and it can extend the period of tax-deferred or tax-free growth, possibly for many decades and over several generations. For the stretch IRA to work, you have to follow the tax rules carefully.
HOST: What other things should we understand about Roth IRA’s, 401ks?
KLAAS FINANCIAL: A Roth IRA can fund your first home. If you want to take out some of those investment earnings, you can do so one time. You’re allowed to take up to $10,000 of your earnings to put towards buying a home IF you’re a first-time homebuyer.
Dividends aren’t taxed. Any dividends you’re paid on a stock or security you own in a Roth IRA account aren’t taxed. This is a HUGE deal if you own a dividend-paying stock for many years. It can add up to thousands and thousands of dollars that you won’t ever have to pay taxes on. Can’t beat that.
You can contribute until you file your taxes towards the previous year’s limit.
Catch C.J. Klaas and Maleeah Cuevas on Money in Motion every Thursday on Madison's 1310 WIBA from 8:05-8:35am.