Understanding Roth IRAs
by, Jeremy Reif, CRPS
Is Roth IRAs the right choice for you? This article will help guide you through the decision-making process and help you understand if a Roth IRA is the right retirement plan for you.
Instead of diving right into the decision-making process, it is first more important to understand what is A Roth IRA? It is an individual retirement account that offers tax-free growth and tax-free withdrawals in retirement. Unlike traditional IRAs You elect to pay the taxes up front, contributions to a Roth IRA are made with after-tax dollars, meaning you don’t get an immediate tax deduction. However, the benefit comes later when you can withdraw your money tax-free.
Who should consider a Roth IRA? If you expect your tax rate to be higher in retirement or if you want to secure tax-free income, a Roth IRA might be the perfect fit for you and your portfolio. It’s also an excellent option if you want to diversify your retirement income sources. Some think about taxes a little deeper. Are taxes more likely to go down or up in the future?
Income Limits:
Not everyone qualifies for making contributions to Roth IRAs as they have income limits for eligibility. These income limits change and it is best to see these limits at the IRS’s website. If you’re a high-income earner, you may not be able to contribute directly to a Roth IRA.
Alternative Option 1:
For those that are over the income limits, there is a loophole called the “Backdoor Roth IRA.” This is where you can make nondeductible contributions to a traditional IRA and then convert it to a Roth. Please do not run out to immediately do this. Like many IRS tax codes, there is a catch to this rule. If you make a contribution to an IRA that already has money in you can only convert as a percentage. It is best to create a brand new IRA and keep other accounts completely separate and work very closely with your CPA and financial advisor while doing this.
Alternative Option 2:
Again, those that are over the income limits can also get around this by investing in a Roth 401k through a company retirement plan.
Alternative Option 3:
Maybe income limits are not necessarily the problem. If you’re reading this and feel that you have too much inside your traditional IRA or 401k, some might even consider doing Roth conversions. When doing conversions it is smart to work with a CPA and financial advisor that can help identify a strategy specific to your financial situation. Doing Roth conversions in a pre-planned amount over several years might be the strategy or doing it all in one shot might be another. Below is a video discussing the strategy for doing a Roth Conversion.
It’s essential to understand the trade-offs of a Roth IRA. You won’t get an immediate tax break, but your money will grow tax-free and can be withdrawn tax-free in retirement. It’s a long-term strategy that can provide substantial benefits if planned correctly.
Before making a decision, evaluate your current financial situation, future income expectations, and consult a financial advisor. They’ll analyze your needs and help you make an informed choice about whether a Roth IRA is the right retirement plan for you. Work with a financial planner that specifically does tax planning and also coordinate their work with a CPA to make sure that you are making the right moves. Remember Roth IRAs can be a powerful tool in your retirement planning arsenal. Consider your tax situation, future income expectations, and eligibility requirements to determine if a Roth IRA aligns with your financial goals.
References:
https://www.irs.gov/retirement-plans/amount-of-roth-ira-contributions-that-you-can-make-for-2023
https://www.irs.gov/forms-pubs/about-form-8606