UNRAVELING THE RIDDLE OF THE ROTH
Does your employer’s 401(k) plan offer poor investment choices, charge high fees, and no match to your contributions? Consider opening an IRA instead. You can choose either traditional or Roth, depending on whether you want to pay taxes now or later. A traditional IRA is best if you believe you’re in a higher income tax bracket now than you will be in retirement. A Roth IRA is better if you think you’ll be in a higher tax bracket in retirement. You can also have one of each type and contribute some to both in the right circumstances.
If you’ve already contributed to your company 401(k), see if you are able to rollover those funds to a new IRA. Talk to your plan administrator first, and if you are eligible, be sure to arrange for a “direct” rollover so the money will be sent directly from your 401(k) to your IRA, and there’s no risk that you’ll be taxed for a distribution. Heard of the 60 day rule? If you have a check written out to you, you have 60 days to put it into another qualified account before it becomes taxable.
One of the limitations of IRAs is that you can only contribute up to $6,000 in 2019, or $7,000 if you’re 50 or older, whereas you can contribute up to $19,000 to a 401(k) in 2019, or $25,000 if you’re 50 or older. This limit applies to all of your IRAs, not to each one individually. So you can’t contribute $6,000 to a traditional IRA and $6,000 to a Roth IRA. If this ceiling is too low for you, consider maxing out your IRA first and then put any extra savings in your 401(k) to take advantage of the tax-deferred growth.
A Roth IRA is a retirement account that you fund with post-tax income. You will pay ordinary income tax on both contributions and earnings withdrawn from a traditional account in retirement, whereas post-tax contributions stashed in a Roth can produce tax-free earnings. In spite of the fact there is no up-front tax deduction for Roth IRA contributions, as there is with a traditional IRA, remember Roth distributions are tax-free when you follow the rules.
If you qualify, 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 for young professionals who won’t miss the upfront tax deduction and will benefit from decades of tax-free, compounded growth.
For the 2019 tax year, here’s what you can put in a Roth IRA, depending on your income, age and tax-filing status:
For the first time in six years, the IRS increased the contribution limits for IRAs, including Roths. In 2019, you can contribute up to $6,000 if you’re under 50. For those 50 and older, you can contribute up to $7,000 per year. You can contribute the maximum $6,000 to a Roth IRA ($7,000 if you are age 50 or older by the end of the year). For 2019, eligibility to make annual Roth contributions is phased out between modified adjusted gross income (MAGI) of $122,000 and $137,000 for unmarried individuals. For married joint filers, the 2019 phase-out range is between MAGI of $193,000 and $203,000.
While there are income limitations for Roth IRA contributions, there is no age maximum. Unlike traditional IRAs, which prohibit contributions after age 70½, Roth IRAs allow contributions at any age.
To further the cross-generational appeal, Roth IRAs are great for older, wealthier taxpayers 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.
Because owners of Roth IRAs do not have to take required minimum distributions, the money in the account can grow tax-free for a long period of time. If you do need to tap the account, you can withdraw any of the money tax-free once you are 59½ or older and have had at least one Roth IRA open for five years.
The Roth 401(k) is becoming more commonplace these days. Roth 401(k)s can be a particularly great option for high earners because there are no income limitations to contribute. You put in after-tax contributions that grow tax-free, and future withdrawals are tax-free. You can also stash significantly higher amounts in a Roth 401(k).
Unlike Roth IRAs, Roth 401(k)s do have required distributions once you hit age 70½, unless you are still working for the employer that sponsors the plan. If you are no longer working, you can avoid RMDs from the Roth 401(k) by rolling the money into a Roth IRA. Besides directly contributing to a Roth IRA, you can convert money from a traditional IRA to a Roth IRA. The amount you convert will be added to your taxable income for the year, so beware that converting too large an amount might spike you into a higher tax bracket than usual.
Conversions come with virtually no limitations, no income thresholds, earned income requirement or age ceiling, and are an easy way for high earners to build a Roth nest egg. Like regular contributions to a Roth IRA, the earnings on a conversion won’t be tax-free until you hit age 59½ and have had one Roth IRA open for at least five years. There’s a second five-year test that applies to the amount you actually converted: those younger than 59½ have to wait five years after the conversion to tap the converted amount penalty-free. If you’re under 59½ and tap the converted amount within the first five years of the conversion, you’ll pay a 10% early-withdrawal penalty. Do a conversion after you are age 59½, and you don’t have to worry about the five-year conversion test at all.
Starting this year, conversions from a traditional IRA to a Roth IRA can no longer be reversed (that has always been the case with 401(k) to Roth IRA conversions). Tax reform took away the ability to re-characterize a Roth conversion if you needed to shrink your tax bill for the year.
Wish you had contributed to a Roth IRA for the 2018 tax year? You still can; you have until April 15, 2019, to make your contribution for 2018. And once it’s Jan. 1, 2019 or later and you’ve maxed on the $5,500 you can contribute in 2018, start on the $6,000 for 2019.
CONTACT US: Like beauty, the benefit of a Roth IRA is in the eye of the beholder. It all depends on the beholder’s tax bracket—both now and when they retire. Having a Roth as part of your nest egg provides tax diversification and flexibility with no mandatory withdrawals. Feel free to contact me, Cory Lyon, directly at 561-209-1120, if you need to reexamine your retirement strategy because your financial situation has changed. At TFG Financial, we believe in customized investment portfolio design and personalized asset management. I act as a fiduciary for all my clients.
TFG Financial Advisors, LLC is a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any securities, and past performance is not indicative of future results. Investments involve risk and are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed here.
