Ep 15: Roth IRA 101

On This Episode

Last week we covered the basics of the traditional IRA and today we will shift our focus to the Roth IRA. John and Nick will once again explain the basics to this investment vehicle. We will also compare and contrast the Roth IRA to the traditional IRA.

 

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Disclaimer:

PFG Private Wealth Management, LLC is an SEC Registered Investment Advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. The topics and information discussed during this podcast are not intended to provide tax or legal advice. Investments involve risk, and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed on this podcast. Past performance is not indicative of future performance. Insurance products and services are offered and sold through individually licensed and appointed insurance agents.

Here is a transcript of today’s episode:

Speaker 1: Hey everybody. Welcome back in to Retirement Planning Redefined. Thanks for tuning into the podcast. We appreciate it. Maybe you’ve received this podcast through the team’s newsletters or email blast. Or maybe you found us online on various different podcast outlets like Apple or Google or Spotify. Either way we appreciate your time. And we’re going to spend a few minutes with John and Nick talking some more about IRAs. And this go round we’re going to spend some time on the Roths. But first guys, what’s going on? How are you?


John: I’m good. So my one year old is sleeping through the night very well, so I feel like a new man.


Speaker 1: That goes a long way that’s for sure. Well kudos on that. And Nick, how you doing, buddy?


Nick: I’m pretty good. My 15 year old dog is not sleeping through the night.I’m okay.


Speaker 1: Yeah, getting up there. I’ve got a 13 year old dog and she’s a pistol. I got a 22 year old daughter and I can’t tell which one’s a bigger pain in the butt, the dog or the daughter. But they’re both doing pretty well. The kid’s actually graduating from nuclear engineering school. Actually I get to go see her Friday, and she’s now a petty officer. She ranked up in the Navy. So we’re all proud of her.


Nick: Congrats.


Speaker 1: Yeah, I appreciate that. I’ll tell you what, let’s not talk about babies, dogs or the Navy for just a minute. Let’s talk about the Roth IRAs as I mentioned. So if you happened to catch the last podcast, we wanted to go through and talk about IRAs, about the vehicle. And we spent some time on the traditional side. So guys, do me a favor first, let’s just do a recap, a little bit, of the traditional IRA before we switch over to the Roth so people have some context on that.


Nick: So one of the biggest benefits for any sort of IRA account are some of the tax benefits. But one of the things that we wanted to remind everybody of, and this helps with IRA accounts, but also just really any investment account. Sometimes the feedback we’ve gotten is it’s helpful for people to think about the different types of accounts in three phases of taxation. There’s as the money goes in, is it taxed, is it not taxed. As the money grows, is it taxed, is it not taxed. And then when it comes out so that you can use it, is it taxed or not taxed. So for traditional IRA, you know the first one, as it goes in, in the last session we talked a little bit about it. Most of the time for most people it’s not going to be taxed. But there will be some rules on when that’s after tax money, it’s going to grow tax deferred. So you’re not going to get 1099 on it each year as it grows. And then when it comes out, it’s going to be ordinary income tax.


Nick: And then for the Roth IRA, which is what we’re going to get into today, it is money that’s already been taxed is going to go in. It’s going to grow tax deferred. So [inaudible 00:02:43] 1099s, and then on the backside it’s tax free. That’s the comparison as you go through.


Speaker 1: Okay. Since you brought it up, let’s go ahead and just jump right into it. So John, give us a few things to think about on the Roth side. He already mentioned the tax deferred part. What are some other limitations and things of that nature we talked about like with the traditional, some numbers or some things we need to know?


John: Yeah, so like the traditional IRA, the contributions are based off of earned income. So again, that does not count real estate state income, any interest, income like that, but earned income. And as far as the limits go, if you’re below 50, [inaudible 00:03:20] 6,000. Anyone above 50 can do 1,000 catch-up, which gives you a 7,000 total. And just to again reiterate some mistakes we’ve seen where you can only contribute 7,000 between the two of you. You can’t contribute 7,000 each. Okay, so 7,000 total.


John: And something that some people aren’t aware of is that even if, let’s say one spouse is not working and is staying home for whatever reason. They are eligible to make a spousal contribution to an IRA, whether that’s Roth or traditional, which is a nice feature because that does come up quite a bit. So to talk about the contributions of a Roth, we gave the example of traditional IRA as far as making a pre tax contribution. As Nick mentioned, the Roth is after tax dollars. So example of that, 100,000 of income for somebody, they make a $5,000 contribution to a Roth, their taxable income stays at 100,000 in that given year. So there’s no tax benefit up front with the Roth IRA versus a traditional IRA, you could have a tax savings up front when you make the contribution if it’s deductible.


Nick: So from an eligibility standpoint, for a single person, somebody that makes under 122,000 can make a full contribution. If their income is between 122,000 and 137,000, there is a partial that can be made. If their income is over 137,000, they are not able to make a contribution to a Roth IRA. For married filing jointly, if their income is below 193,000, they can make contributions for both of them and their spouse. If the income is between 193 and 203,000, it’s a partial. And if the household or the married filing jointly income is above or greater than 203,000, then they are not eligible to make the contribution.


Speaker 1: Gotcha. Okay. All right, so we’ve covered some of the contributions, some of the eligibility you mentioned already in the tax deferred growth part. What about access? Did we cover some things there?


John: So one thing the eligibility and it’s becoming more popular now with Roth 401k. So if you’re not eligible to make a Roth IRA contribution, one thing to do is check with your employer and see if they offer a Roth 401k, which actually has no income limits for you to be able to participate in it, which is a nice [inaudible 00:05:37]


Speaker 1: Okay, that’s good to know. Yeah, absolutely. All right, that’s a Roth 401k. Maybe we’ll do another show about that another time. What about the access side, anything there? Is it the same 59 and a half, all that kind of stuff?


John: So rules are fairly similar, where you as far as access getting to the account, there is the 59 and a half rule. And if you do draw early there’s a 10% penalty on your earnings. And I stress earnings on that, because with a Roth IRA and I say this, consult with your tax preparer, tax advisor, we don’t give tax advice. But with a Roth IRA, you can actually access what we call cost basis prior to 59 and a half without any penalty. I’ve seen a couple of people do it where basically let’s say if you’ve put in 30,000 into your Roth in your account at 50. So 20,000 earnings, 30,000 is what you’ve put in, which is considered your cost basis. You can pull that 30,000 out without paying a penalty. It’s just you have to keep very good records of your contribution amounts. And if you do pull it out, you have to work with your tax preparer to go ahead and let the IRS know that you pulled out a portion of your tax basis. And that’s would avoid any type of a penalty on that.


Speaker 1: All right, so we’ve covered several things on the Roth side, so the access, the eligibility, contributions, all that good kind of stuff. So let’s just get into the fact that it’s been hugely popular. It’s been a very hot button issue for the last really couple of years. Obviously one of the reasons, we mentioned earlier that it’s tax deferred. Really, the taxes are low, right? We’re in a historically low tax rate. So one of the reasons that a Roth might be a good place to go, or a Roth conversion I guess I should say, is because of the tax thing. So what are some other reasons why the Roth is just really popular?


Nick: You pointed to one of the biggest reasons from the standpoint of we are in historical low tax brackets. And one of the things that we talk about with clients and it really became evident towards the end of 2019 is, the thing that might be the quote unquote best strategy today, it may not be the best strategy five years down the road, 10 years down the road. So for most of the clients that we meet with, they’re substantially overweight on pre-tax money and maybe only recently have started to build up Roth money. And we think it’s really important to have balance and to have options in retirement. Your ability to be able to pivot and adjust to law changes, rule changes, market conditions, etc. are really important. And then part of that is not having to be forced to take out a required minimum distribution on a Roth helps you maintain that balance and maintain the nest egg, those tax free [inaudible 00:08:18] roles help give you flexibility and balance, the ability to be able to pass on funds to beneficiaries, Roth dollars.


Nick: Especially if you have… Maybe your kids are high-income, you’ve done a good job planning. We go through the numbers, we built the plan and there’s a pretty high probability that you’re going to be passing on money to the kids. The rub, money is usually much better to plan or to pass down, because of the fact that it will be tax-free to them as well. So the ability to really create flexibility in your planning and strategies is one of the reasons that we think the Roths are a really important piece of the pie.


John: Just to jump in. One thing, just backtracking to accessing it tax-free. Just a couple of rules with it is you have to be above 59 and a half. And you actually have to have had a Roth IRA account for at least five years. So an example would be, let’s say I open one up at age 60. I’m above 59 and a half. The person cannot actually withdraw tax free until basically 65. So I have to wait five years and that’s from the first Roth I ever started up. So one thing that we typically will work with clients is if they’re eligible, we might just go ahead and start a Roth IRA just to start that five year window.


Speaker 1: Okay. All right. That’s good. Yeah. Good information to know on that. Now with the beneficiary thing and passing things along, is the change in the SECURE act, does that make a difference in the Roth as well? Is there anything there that would pertain to people if they’re thinking about it that they should definitely be checking with you guys on before doing a conversion or something like that?


John: Yeah, so I believe we’re doing a four part session to this. We’re going to talk about conversions, but yeah, that makes conversions a little more appealing where you have to pull the money out over a 10 year period now. Where basically at least if you have to pull it over 10 years, there’s actually no tax hit. So as your IRA gets bigger, if you’re pulling out of a $1 million IRA over a 10 year period, that’s going to really affect your tax rate. If it was all Roth money, it would have no bearing on your taxes.


Speaker 1: Gotcha. Okay. All right. Yeah, and we are going to continue on with this conversation on a future podcast about which one might be right for you and all those good kinds of things. Nick, anything else that we may have overlooked in there we need to throw in?


Nick: No, I just can’t really say it enough from the standpoint of building in flexibility is key. Most of the people that listen to the podcasts are going to have pretax money, but if they don’t have any Roth money then just getting started can be really important to build that up. Because even if they’re within a few years of retirement, just remember that we’re still planning for 30, 40 years down the road. Having money that compounds over a long period of time and then has tax free withdrawals on the backside is a pretty significant leverage point and benefit.


Speaker 1: Okay, one final question I’m going to ask you guys is you sometimes hear people say, if I’m still working, can I contribute or should I contribute to both kinds, the traditional or the Roth? What do you say when someone asks that type of question? Should someone do both the traditional for the tax reasons and then the Roth for the non-tax? What’s your answer?


John: We’ll answer that in the next session.


Speaker 1: Nicely done. Look at him teeing that up. There you go, folks. All right, I’ll tell you what. We will take care of that on the next session and that way you have a reason to come back. A cliffhanger if you will. So if you’ve got questions about the Roth IRA, make sure you talk with your advisor about that. If you’re not working with an advisor, you certainly should be. Reach out to John and Nick and give them a call at PFG Private Wealth. And you can reach them at 813-286-7776. That’s the number to dial. 813-286-7776 here in the Tampa Bay area or go to their website, check them out online at pfgprivatewealth.com. That is pfgprivatewealth.com. Don’t forget to subscribe to the podcast so you can get those next episodes as they come out. Nick, John, thanks for your time this week.


Speaker 1: I hope everybody has a great week and you guys enjoy yourself and continue to get some good sleep while that baby’s resting, all right?


John: Hopefully it continues. I think it will.


Speaker 1: Yeah, there you go. Nick, appreciate your time, buddy. Take care.


Nick: Thanks. Have a good one.


Speaker 1: We’ll see you next time here on Retirement Planning Redefined with the guys from PFG Private Wealth, John and Nick.