Last Week’s Question of the Week: Do interest rates and bond prices move in the same direction, or the opposite direction?
ANSWER: Interest rates and bond prices move in opposite directions.
HOST: Today’s discussion will revolve 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: Yes, that’s right. So, let’s first establish the difference between Roth IRAs and Traditional IRAs, or Roth 401ks and Traditional 401ks.
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 or traditional 401k. Roth IRA’s have the SAME contribution limits as traditional IRA’s.
2019 Contribution limits are: $6,000 for earners under 50, and $7,000 for earners over 50 years of age for earned income per year. Again, remember in a Roth IRA or Roth 401k situation, 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.
HOST: What are the requirements to have a Roth IRA? How do I qualify? And can I put away money into both a Roth IRA and traditional IRA?
KLAAS FINANCIAL: Those are great questions!
You can contribute to a Roth IRA at any age as long as you have earned income from a job. That means they are appropriate for everyone from your children or grandchildren who have earned income.
You do need to know that Roth IRAs have income eligibility limits, so if you make too much money, you can’t contribute to a Roth IRA, however you may be able to make a partial contribution (phaseouts) depending on where you fall with your income.
In 2019, the AGI phase-out range for taxpayers making contributions to a Roth IRA is $193,000 to $203,000 for married couples filing jointly; For singles and heads of household, the income phase-out range is $122,000 to $137,000.
It doesn’t matter what kind of IRA’s, the TOTAL amount one person can contribute to all of their IRA’s (Roth & Traditional), in the 2019 tax year, you can put in a max of $6,000 into a Roth IRA or Traditional depending on your income, age and tax-filing status. ($7,000 if you are age 50 or older by the end of the year)
HOST: What are some of the benefits of owning a Roth IRA?
KLAAS FINANCIAL: 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. 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.
In terms of estate planning, Roth IRAs 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. Well-funded retirees can leave their Roth money untouched if they don’t need it.
HOST: Are ROTH IRAs more flexible than Traditional IRAs?
KLAAS FINANCIAL: Yes, beyond tax rates, some unique features of the Roth may influence your decision about whether to contribute to a Roth IRA.
- Flexibility: You can withdraw your contributions at any time without taxes or penalty. Although you normally must hold the Roth account for at least five years and be at least 59½ before you can tap the earnings tax-free and penalty-free, (there are exceptions, including death or disability of the account holder or to use up to $10,000 to purchase a first home for yourself or certain family members. In addition, you can avoid the 10% early withdrawal penalty, but will still incur income taxes, if you withdraw earnings early to pay higher-education costs for yourself or a family member)
- No mandatory withdrawals: Roth account holders are never forced to withdraw money (traditional IRAs require RMD’s withdrawals beginning at age 70½). This is particularly useful for estate planning purposes because it allows the account balance to continue to grow. Heirs pay no income taxes on inherited Roth IRAs, but they are required to take distributions over their lifetimes.
- Saving during retirement: You can make contributions to a Roth if you continue to work past retirement age, as long as you stay within the income limits. Traditional IRAs do not allow contributions after age 70½.
HOST: What about ROTH 401ks available to me at work? Are the returns better than in a traditional 401k?
KLAAS FINANCIAL: For many of our listeners, you may have a choice in your retirement plans to choose a Roth 401k option. So, which choice is better? The initial returns will not be different, but how it reflects today in your taxable income can be a factor.
Things to consider: 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 in 2019 is $19,000 or $25,000 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
INTERESTING TO NOTE: 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 exactly 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 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 is not 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 is 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.
Catch C.J. Klaas and Maleeah Cuevas on Money in Motion every Thursday on Madison's 1310 WIBA from 8:05-8:35am.