Since the Tax Cuts and Jobs Act has been in effect, Roth IRAs have been getting more attention. With income tax rates at historic lows, opting to pay tax now in order to not pay tax later on retirement savings is something American households need to consider. Additionally, Roth’s may apply to you in a way that you haven’t thought about with current legislation. Here are a few things to know:
Tax-Deferred Growth & Tax Free Withdrawals
Roth IRA’s are funded with after tax money, unlike your traditional IRA/401(k) contributions which are pre-tax. Once you put money in you will never pay taxes on future withdrawals, including investment gains…as long as you satisfy the following requirements:
· You are 59½
· You have had a Roth for a minimum of 5 years
*Like most retirement accounts, there are penalties for early withdraws before 59½.
No Required Minimum Distributions
Once you reach 70 1/2, the IRS requires you to take distributions from your traditional IRA & 401(k) accounts every year. Roth IRA’s do not have these rules giving you greater flexibility in retirement and a great asset to leave to beneficiaries.
For 2019, the limit is $6,000. If you are over 50 you can contribute an additional $1,000 for a total of $7,000, on earned income. There are income limits on these so make sure you are aware of those based on how you file your taxes.
“Back Door” Provision
If your income level is above IRS limits that allow for Roth contributions, there is a way for you to “back-door” your way in to making contributions… via a non-deductible IRA contribution - then converting it over to a Roth. This is one where you will want professional advice from someone understands these, as they can have unintended tax consequences.
If you have money in a Traditional IRA, you may be able to get a large sum into a Roth by doing a conversion. Know this, you will pay income tax on the amount that you convert over to the Roth in that tax year.
Based on today’s federal income tax rates, paying tax now during times of lower tax rates to avoid paying higher tax rates later is worth considering. This is a conversation that you should consider having with a tax professional.
My opinion, I think future tax rates are likely to be higher than they are right now.
Depending on how much you have in your IRA or 401(k) it may make sense to have a multi-year plan to slowly get the money converted over to a Roth. This can help avoid throwing you in to a higher income tax bracket. The sweet spot, I’ve found, is for those who are currently in the 22-24% tax bracket before you jump to the 32% tax bracket.
Let’s say you are married filing jointly and want to do a Roth conversion. Your combine income is $175,000 and you want to convert your spouse’s Traditional IRA that is valued at $200,000. If you were to convert the entire amount in the same year, a portion of that $200,000 would be taxed at 32% instead of 24% (see below 2019 tax rates). A better alternative would be to spread that out over 2-3 years to keep your income tax rate down.
Everyone’s personal situation is different so be sure to talk to a professional before making any decisions.