Last Week’s Question of the Week: If you are under 59 ½ and you wish to withdraw money from your IRA or other similar retirement accounts, what is the penalty for doing so? ANSWER: Generally, if you are under 59 ½, distribution of these monies from these plans will be charged a 10% penalty.
HOST: Today’s discussion revolves around a special kind of IRA, a Roth, and also about Roth Conversions?
KLAAS FINANCIAL: Yes, so we have a lot of information to cover today, but hopefully take away some of the mystery of what a Roth IRA and Roth 401k is and is not.
We know many people have them as part of their portfolio, but we want to hopefully open up some good dialogue for why it may make sense to have one at certain ages, and maybe why not.
First of all, the Roth IRA has not been around too long, as it originally started with the Tax Relief Act of 1997, named after late Senator William Roth of Delaware.
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, So, you do pay taxes now.
On the other hand, 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.
That makes Roth IRAs 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 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.)
HOST: So what are the requirements to have a Roth IRA? How do I qualify?
KLAAS FINANCIAL: Great question!
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.
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.
If you are single or the single head of a household and your modified adjusted gross income is less than $120,000 or if you are married filing jointly, you can contribute the maximum amount to a Roth IRA if your MAGI is less than $189,000 in 2018.
You may have an option in your retirement plan at work to add money to a Roth 401k. The limit for this in 2018 is $18,500 if you are under 50, or $24,500 if you use the $6000 catch-up. There are no income limitations to contributing to ROTH 401ks.
HOST: So, if my income allows for it, how much can I put away into a Roth IRA? And can I do both, put money into a Traditional and ROTH IRA?
KLAAS FINANCIAL: 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 2018 tax year, you can put in a max of $5500 into a Roth IRA (or Traditional), depending on your income, age and tax-filing status. ($6,500 if you are age 50 or older by the end of the year)
Remember, 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 about Roth Conversions? What does this actually mean?
KLAAS FINANCIAL: So there is a term some people may have heard which is, a “backdoor Roth” which is simply a conversion from their traditional IRA over to a ROTH IRA.
Why is it called a backdoor? Simply because maybe your income was too high to qualify to add money to a Roth 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: What other benefits to having a ROTH IRA?
KLAAS FINANCIAL: So there is a term some people may have heard which is, a “backdoor Roth” which is simply a conversion from their traditional IRA over to a ROTH IRA.
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.
Catch C.J. Klaas and Maleeah Cuevas on Money in Motion every Thursday on Madison's 1310 WIBA from 8:05-8:35am.
