The Roth Advantage

The Roth Advantage Part 1: The Basics

Dan Kresh FPQP™

Would you rather have a small tax deduction this year or tax-free retirement money in the future?

The unique advantages of a Roth IRA make it one of the most powerful ways to save for retirement and beyond, especially for people early in their careers. Time is one of the biggest factors impacting how you should invest.  The more time you have, the more advantageous the Roth IRA can be. 

For Millennials, there are numerous advantages to opening a Roth IRA.  Assuming your income does not exceed the limit[i], for many, the Roth IRA is the best place to start retirement planning in my opinion.  Though you can’t take deductions when contributing to a Roth IRA, future distributions are tax free if they meet certain requirements.  This gives you a unique opportunity to pay a potentially lower tax rate now, without the gains being taxed in the future! 

The Roth IRA is best for those who are in lower tax brackets, and whose income is expected to grow.   The lower your taxes are now, the smaller the impact on your tax bill if your contributions are not deductible.  You may never be in a tax bracket this low again!

With a Traditional IRA, though contributions are deductible now, all the distributions count as income for tax purposes.  This means that 100% of distributions from a Traditional IRA will be taxed at your highest marginal tax bracket each year!  With current tax laws, your ordinary income is taxed at a higher rate than long term capital gains[iii]. Since all distributions from a Traditional IRA count as ordinary income, they would have a larger tax burden than selling investments outside of retirements accounts.   Distributions from a Roth IRA are tax free[iv]!   

You are never required to take distributions from a Roth IRA! You can also keep contributing to a Roth IRA as long as you have earned income.  With a Traditional IRA, when you turn 701/2[v] you will need to start taking distributions, and can no longer make contributions. You can’t avoid paying those taxes forever.

There are many other unique and advantageous properties that Roth IRA’s offer.  This is part 1 in a series of articles I will be writing over the next few months outlining some of the other differences and potential benefits of Roth IRAs.  Keep your eyes open for Part 2 with important information for first time homebuyers.

Remember, it’s never too early to start thinking about retirement.  The earlier you start the more time you have for growth.  You work hard for your money, we work hard so your money can work for you. 


[iv]A Roth IRA distribution is qualified if you’ve had the account for at least five years and/or the distribution is made after you’ve reached age 59½, because of your total and permanent disability, in the event of your death or for first-time homebuyer expenses.  Distributions made prior to age 59 1/2 may be subject to a federal income tax penalty.  If converting a traditional IRA to a Roth IRA, you will owe ordinary income taxes on any previously deducted traditional IRA contributions and on all earnings

[v]http://www.investopedia.com/articles/retirement/09/over-70-retirement-plans.asp

 

You should always consult a tax professional and though this piece contains some tax information it should not be considered tax advice.  

 

The Roth Advantage Part 2: First Time Homebuyer

Dan Kresh FPQP™

There are ways for first time homebuyers to access some funds from retirement accounts without "penalty". Though you may be able to avoid an early withdrawal penalty, you will be lowering the amount in your retirement account. You would likely be purchasing your first home many years before you plan to retire, depleting your account when it has the most time to grow. This is a complicated decision. It is important to understand the differences between how you could access funds early from Traditional or Roth IRAs.

A first-time homebuyer can access up to $10,000 from either a Roth or Traditional IRA to contribute towards a down payment[i]. Any funds taken out from a Traditional IRA, for any reason, including a first-time home purchase would be taxed as ordinary income. The tax deferred nature of the Traditional IRA is its biggest advantage, so using funds from a Traditional IRA to help fund a home purchase will forfeit some of that benefit while shrinking your nest egg.
With a Roth IRA, you can take out contributions at any time for any reason without a tax consequence since it's already after-tax dollars[ii]. The Roth IRA owner can also access up to $10,000 of profit for a first-time home purchase, and if you have had the Roth for more than 5 years that would be tax free.[iii] You should NEVER consider a retirement fund an emergency fund, however; the fact remains that there are less barriers and penalties to accessing funds from a Roth IRA early than from a Traditional IRA.

Tapping into your retirement account to buy a home should not be your first choice, but it's nice to know what options could be on the table. You have the best chance of growing your nest egg if you contribute the maximum into your IRA for as long as possible. Taking funds out of your retirement account before retirement age, with or without penalty and or tax, means you will have a smaller principal to hopefully compound over time. Your retirement money will serve you best in retirement and should be invested in a well-diversified portfolio for the long haul. Any investment involves the risk of loss of principal but the more diverse your investments and the longer your time horizon the better your chance is to mitigate that risk. 

If your income is at or approaching limits for contributing to a Roth IRA part 3 of this series will discuss a potential way for you to contribute to a Roth IRA using Roth conversions. It's never too early to start thinking about retirement. The earlier you start the more time you have for growth. You work hard for your money, we work hard so your money can work for you.


[i] IRS
[ii]Roth IRA Withdrawl
[iii]IRA To Buy A House

 

A Roth IRA distribution is qualified if you've had the account for at least five years and/or the distribution is made after you've reached age 59½, because of your total and permanent disability, in the event of your death or for first-time homebuyer expenses. Distributions made prior to age 59 1/2 may be subject to a federal income tax penalty. If converting a traditional IRA to a Roth IRA, you will owe ordinary income taxes on any previously deducted traditional IRA contributions and on all earnings.

You should always consult a tax professional and though this piece contains some tax information it should not be considered tax advice.

 

The Roth Advantage Part 3: Roth Conversions

Dan Kresh FPQP™

If your income is above the limit to contribute to a Roth IRA [i] , that doesn’t mean you can’t get money into one.  No matter your income (assuming your less than age 70 ½ and have earned income) you can contribute to a Traditional IRA.  There may be limits to the deductibility of contributions for high income earners, but non-deductible IRA contributions could be made at any income level.[ii]
 
There’s a perfectly legitimate workaround to get funds into a Roth IRA indirectly; regardless of your income, if you pay income taxes on the funds going in.  The Roth Conversion or “back door” enables you to convert funds from a Traditional IRA to a Roth IRA [iii].  This could allow you to convert contributions each year or convert any amount (principal or interest) to a Roth.[iv]  
 
With a conversion, typically, the entire amount you convert, whether it’s deductible contributions or profit, counts as income in the year you convert[v] . Consulting a tax professional is recommended if you are considering Roth conversions.  Depending on your individual circumstances, and time horizon, converting to a Roth could be financially beneficial.
 
In my opinion, if your IRA contributions are already non-deductible due to your income, it’s a no-brainer to convert those contributions to a Roth each year.  It’s a win-win.  If your IRA would have after-tax money anyway, why shouldn’t you take advantage of the Roth?  I think the only valid benefit of a traditional IRA over a Roth IRA is the deductibility and if that’s already off the table I would go Roth all the way.
 
In addition to converting new contributions each year you also can convert any and all of the funds you have accumulated in a traditional IRA.  Since the entire amount converted could be counted as income in the year you do it, there should be careful tax planning, with a tax professional, regarding a Roth conversion strategy.  This may be something you spread over multiple tax years.  
 
You may have unique onetime deductions, in certain tax years, for a variety of reasons that ease the pain of the conversion.  Perhaps you would be due a refund, equal to the tax liability of the conversion. Would the benefits of the Roth IRA be worth more to you than the refund?  Maybe you’re at a crossroads in your career and your income is abnormally low, due to searching for a new job or going back to school.  Maybe you bought a house and or solar panels and have extra deductions and credits. The list goes on and on.
 
I think, objectively, if you’re investing your retirement money and it grows, the longer your investments are in a Roth the more advantageous it is.  I am more than happy to meet with you to discuss setting up a Roth IRA or facilitate a meeting with you and your tax professional to discuss a strategy for conversions.  You work hard for your money, we work hard so your money can work for you.  

[v] If you have a mix of deductible and non-deductible contributions in a Traditional IRA there is added complexity in the proper tax reporting of conversions.  If converting a Traditional IRA to a Roth IRA, you will owe ordinary income taxes on any previously

deducted Traditional IRA contributions and on all earnings. A conversion may place you in a higher tax bracket than you are in now. Because Roth IRA conversions may not be appropriate for all investors and individual situations vary we suggest that you discuss tax issues with a qualified tax advisor.

 

You should always consult a tax professional and though this piece contains some tax information it should not be considered tax advice.

 

The Roth Advantage Part 4: Prior Year Contributions

Dan Kresh FPQP™

Since Roth IRA contributions are made with after tax dollars, there is no need to report them on your tax return.[i]  This is another benefit of Roth over Traditional IRAs.  Contributions to a Traditional IRA, even non-deductible ones, must be reported on your tax return[ii].

The deadline for IRA contributions is not the end of the calendar year. For contributions to a Roth or Traditional IRA, the deadline is the same as the tax filing deadline.  So, for 2017 contributions the deadline is April 17, 2018[iii].  Though this deadline is for both Roth and Traditional IRAs, the fact that Traditional IRA contributions must be reported makes last minute contributions tricky if you filed your taxes early.  Since you don’t need to report Roth contributions you can still make a contribution even if you have already filed your tax return early, without any further paperwork. 

The takeaway is there’s still time to make a prior year contribution up until the tax deadline.  You have about 15½ months to make a contribution for a calendar year, from January 1st through the tax filing deadline.  This also means that if you didn’t make a prior year contribution, you can make two contributions between January 1st and the tax deadline (prior year and current year).

There’s no time like the present to invest in your future. You work hard for your money, we work hard so your money can work for you.    


[iii] https://www.irs.gov/newsroom/2018-tax-filing-season-begins-jan-29-tax-returns-due-april-17-help-available-for-taxpayers

 

You should always consult a tax professional and though this piece contains some tax information it should not be considered tax advice.

 

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