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E-mail: pwa@keatinginc.com
Phone: 773-975-4020

Beth Kraszewski named as Top Best-in-State Woman Wealth Advisor by Forbes

Maximize the Power of a Roth IRA

How Can You Maximize the Power of a Roth IRA for Your Short and Long- Term Money Goals?

Believe it or not, there are several ways to fuel your goals by deciding how to best grow your IRAs and manage them over the course of their lifecycles.  We hear comparisons between regular IRAs and Roth IRAs, but what is the most important difference?

Here it is:  a Roth IRA is funded from funds already taxed, so the money funding it goes in the account AFTER tax.  Therefore, if you are above age 59.5 when you start taking distributions, the distributions (which are made up of capital and growth income) are distributed tax free to you. Why is this beneficial? Generally, if you’re younger, it can be expected that your tax bracket will increase in the future, as you will likely earn more or be promoted. So, by paying taxes now in a hopefully lower tax bracket, you’re paying less in taxes than you would in the future.  You also needn’t be as concerned about what inflation will do to your savings profile.

By contrast, Traditional IRAs are funded with PRE-TAXED funds, and when these funds are ultimately distributed, the distributions (also made up of principal and growth income) are taxed at whatever rate is applicable at the time of distribution.

Also, Roth IRAs aren’t subject to required minimum distributions. With Traditional IRAs, you MUST take required minimum distributions (RMDs) once you reach age 70.5, or you will face a hefty penalty. Therefore, Roth IRAs can be a great inheritance option, as the money can grow tax free during your lifetime, and it’s only once you’ve passed away that your beneficiaries will have to start taking required minimum distributions (RMDs).

You can contribute the greater of earned income or $6,000 in 2019 to a Roth IRA annually. Also, if you are age 50 or above, you can contribute an additional $1,000, called a “catch-up contribution.” Your contributions are subject to an income phaseout detailed below:

  • If you are single, you must have an AGI (adjusted gross income) of under $137,000 for the 2019 tax year but contributions are partially reduced starting at $122,000.
  • If you are married filing jointly, you must have an AGI (adjusted gross income) of under $203,000 for the 2019 tax year but contributions are partially reduced starting at $193,000.

Don’t worry, even if you make too much money to contribute to a Roth IRA, there are ways to achieve similar results.  We will give an overview of three popular strategies:

  1. Backdoor Roth IRA
  2. Roth 401k Contribution
  3. Cash Value Life Insurance

Backdoor Roth IRA

To navigate around the income limitations, you can fund a traditional IRA and then convert the money into a Roth IRA. Regardless of AGI, you can contribute $5,500 into a traditional IRA with an extra $1,000 if you’re over 50. If your AGI is above the phaseout limits, your contributions are non-deductible. When you make the conversion to a Roth IRA, you don’t owe taxes on contributions, because you’ve already paid the taxes on those. However, you will have to pay taxes on the earnings just as if you take a withdrawal from your account. Typically, there is no waiting period for conversions, so you can do it shortly after you make the traditional IRA contribution, when the amount of earnings is very small. Therefore, the taxes you owe will be small and you will have tax free growth from there on out.

Roth 401k Contribution

A Roth 401k is a new option that many companies have recently been adopting. The Roth 401k and the Traditional 401k use the same investment options. The Roth 401k investments are after-tax investments, meaning the contributions will come out of your paycheck after you have paid income taxes. Roth 401k withdrawals are tax free, unlike the Traditional 401k. The contribution limits are the same as a Traditional 401k, and you can contribute to both in the same year if you don’t breach the $18,500 annual limit.

If you decide to take withdrawals before age 59.5 in a Roth 401k, you can take out your contributions tax free, as long as you’ve held the account for more than 5 years. If it were a regular 401k, then you’d be taxed at your ordinary income rate and be subject to a 10% premature distribution penalty. Additionally, your Roth 401k doesn’t have RMD requirements once you reach age 70.5, making Roth accounts great options for inheritance and legacy planning. However, if you do plan on using the money during retirement, regardless of what tax bracket you’re in, the money has already been taxed, making it a steady, tax free revenue source for you to enjoy.

Cash Value Life Insurance

Individuals are able to take loans from cash value life insurance policies. Similar to how a Roth account works, the loans from life insurance are tax-free. While this can have major benefits to some individuals, we only recommend utilizing cash value life insurance as a Roth Workaround in a limited strategy, specifically for someone that already has a need for permanent life insurance.

Roth Workarounds

Overall, a Roth can be a great opportunity to those that want to pay tax now in order to save money in the long run. If a Roth IRA is not an option for you, utilizing other strategies like the Backdoor Roth IRA, Roth 401k Contribution, or Cash Value Life Insurance could be a great way to achieve similar tax strategy.

If you would like to explore the options that would work best for you and your family, contact us at  pwa@keatinginc.com, or check out our website at www.purposefulwealthadvisors.com.

Matching contributions from your employer for a Roth 401(k) plan may be subject to a vesting schedule. Please consult with your financial advisor for more information. RMD’s are generally subject to federal income tax and may be subject to state taxes. Consult your tax advisor to assess your situation. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion. Financial Advisors of RJFS are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.