Episode #4 -Take Advantage of Roth IRA's and Roth 401k's

Wealth Decisions Podcast Transcript for Episode #4- Take Advantage of Roth IRA's and Roth 401k's

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You know, they say that the only things that are certain are death and taxes.

In today's episode, we're going to talk about a crucial wealth decision that makes taxes a little bit less of an issue down the road.

I think one of the best tools for building and keeping your wealth is the Roth IRA and Roth 401k.

The biggest advantage of the Roth IRA is that you're going to keep the government out of your pocket.

Permanently, tax-free growth and tax-free withdrawals with a Roth IRA, you contribute after tax money so you don't get to avoid tax on your contributions as you might with 401ks and traditional IRAs.

But in exchange for that, your money grows tax free and you're able to withdraw it tax free in retirement at age 59 and a half or older.

One other advantage is that you can actually take out your contributions if you need it to put money down on a house or for education.

Those are just a couple of the benefits.

And we're going to we're going to talk a little bit about how you can get more money in Roth IRAs so that down the road you have a significant sum of money that you can pull out tax free.

So number one, consider converting your existing IRA to a Roth IRA if you're in a low to mid tax bracket.

If you'd like a conversion analysis done, you can go to my website and schedule an IRA conversion analysis.

I usually recommend a strategy of partially converting your IRA each year to a Roth, especially if your IRA has a significant amount from past jobs that you rolled over into that IRA.

So, for instance, if you have a hundred and fifty thousand in an IRA and you have thirty thousand of room in your tax bracket where you can still stay in that same tax bracket, then you might want to consider converting thirty thousand a year over five years to get that IRA fully converted into a Roth for the future.

I definitely think it's much more beneficial if you're in a low or mid tax bracket to convert.

If you're in the highest tax bracket possible, it still makes sense, and that's where a Roth conversion analysis would come into play.

So a lot of people ask, why would you do this?

Why would you pay taxes now?

And if you're younger, if you're thirty or forty, the benefit is that much greater because this money is going to grow tax free for a long period of time.

And you're paying taxes now on a smaller amount for tax free benefits down the road.

So if you're in your late fifties, for instance, it still makes quite a bit of sense to do this strategy.

Even with people retiring and they no longer have an income, now their tax bracket is lower.

I do talk about converting some of someone's IRA to a Roth to make sure that we benefit their legacy as well as creating a tax efficient income down the road.

So number two, a lot of folks make too much money.

If you file single or you file jointly, there are income limits on whether you can contribute to a Roth IRA, and you can find those online just by doing a search.

If you make too much money to contribute to a Roth, there is an option that a lot of people are unaware of.

It's called the backdoor Roth option.

If you make too much money to contribute to a Roth, you actually can funnel money into a non-deductible IRA and right away convert it to a Roth.

It's a great way to get money into a Roth IRA, but be careful if you do have a large IRA balance currently from old rollovers.

You definitely want to consult a qualified financial advisor before you do this non-deductible IRA contribution and then convert it into a Roth.

When you have a large IRA and you want to do this non-deductible IRA separately and then convert it to a Roth, there are some calculations that will cause some tax liability on that conversion from that non-deductible IRA to a Roth.

So be aware of that.

Consult with a qualified financial professional before you make a choice to do this backdoor Roth strategy.

Number three, obviously we talked about this already, you get tax-free growth and tax-free withdrawals.

I just want to just give you an example of if you put 6,000 in a Roth IRA every year starting at age 30 and earn a 10% rate of return, by the time you're 65, you could have accumulated about 1.5 million, which all comes out tax-free.

Now, assuming you're in the 28% tax bracket in retirement, you'd have to accumulate about 2.1 million in a normal IRA or 401k to have that same after-tax benefit.

So it's a very, very powerful tool to achieve financial independence or financial freedom.

Another benefit I touched on earlier is that you can withdraw your contributions penalty-free at any time.

A lot of other retirement accounts ding you with a 10% penalty, plus you pay taxes on that withdrawal.

So Roth IRAs can be a great tool for saving for the future, but give you access if you need to put money down on a home or fund education for your family.

There's also no age limit for a Roth IRA.

So your age doesn't prohibit you from contributing to a Roth IRA.

As long as you have some type of earned income from working, not just merely investments, you can contribute to an IRA each year.

In addition, non-working spouses can also contribute to a Roth IRA if they have a spouse who earns income.

Another huge advantage of a Roth IRA is that you don't have to take required minimum distributions.

They call those RMDs.

If you have an IRA or a 401k, you have to start taking money out of your IRA or 401k at age 72.

And that amount equates to about little over 4% when you're 72 and keeps going up the older and older you get.

What ends up happening if you have all of your money in a traditional IRA or 401k, by the time you're in your 80s, that percentage you have to take out is well above 5%.

And by the time you're in your mid to late 80s, it's close to 6%.

So picture this.

You have $4 million in your IRA and you're approaching 90.

I know that's a long ways away for most of us.

But let's say your required minimum distribution is 6% at that time.

But you only need $60,000 a year to supplement your Social Security and maybe your pension if you're lucky.

You'd be required to take out $240,000 per year, which would put you in the highest tax bracket at current federal tax bracket rates.

So your federal taxes would be more than the amount that you would need to live off of.

This is the reason why you need to start putting more money in a Roth 401k or Roth IRA.

I know this is a long ways away, but planning now to make sure that you have a better balance of taxable accounts, tax-deferred accounts, and tax-free accounts to make sure that you have the ability to create a tax-efficient income in retirement is going to be crucial to your financial success during your retirement years.

And the last benefit of the Roth IRA is legacy planning.

I have some clients that it's important to leave a lasting legacy.

It's important to have something left at the end of it all to leave their favorite charities or their family.

The Roth IRA allows you to pass any money in your account tax free to your heirs.

And you're not required to take money out if you inherit a Roth IRA, which is a huge factor now that they've changed the rules for inherited traditional IRAs.

The new rules are if you inherit a non-spousal IRA, you have to take all the money out over 10 years, rather than being able to extend it a long period of time over your life expectancy.

So Roth IRAs can be a great legacy planning tool to incorporate in your financial plan.

So before we wrap up this episode, I'd like to also bring up something that is not available in all 401k plans, but please ask your employer if they have an after-tax option in your 401k.

Not many companies offer this, but you can defer up to $20,000 per year in the after-tax option on top of your 401k contributions.

And then at the end of the year, you can convert that after-tax contribution to your Roth IRA.

It's a super powerful way to get more money in Roth IRAs to make sure that you set yourself up for a brighter future.

One last thing, a wise wealth tip for your Roth IRA.

I'd encourage you to be a little bit more aggressive with your Roth IRA money.

Then you do your 401k and other investments.

And the reason for that, and this is not saying to put it all in one stock or put it all in emerging markets, but be a little bit more aggressive with your Roth IRA money.

Because the more that you can grow that, the more tax-free income you're going to have down the road.

And that will set you up for a really comfortable retirement.

So that's it for today's episode.

Wealth Decision number four.

Invest in Roth 401Ks and Roth IRAs.

If you'd like to schedule a discovery call with me, you can go to my website at momentouswealthadvisors.com and I'll spend some time to get to know you a little bit and find out if I might be able to steer you in the right direction or help you with your financial future.

Listen to this episode on Apple Podcasts or Spotify


-Brian D. Muller, AAMS® Founder, Wealth Advisor

Momentous Wealth Advisors in a fee-only fiduciary advisory firm

Disclaimer: This material is for informational purposes only and should not be construed as investment advice. Past performance is not indicative of future results. Investors should make investment decisions based on their unique investment objectives and financial situation. While the information is believed to be accurate, it is not guaranteed and is subject to change without notice.

Investors should understand the risks involved in owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal.

Always consult with a qualified financial professional before making any investment decisions.