The Confident Dollar Podcast
Join financial advisor Lauren Gage as she discusses how to build confidence in your money. Through episodes you'll learn how to save more, make more & plan for your future in a way that doesn't have you leaving behind how you want to live your life now. And let's not even get started with the shame cycle of money - we ARE leaving that behind. Bite sized episodes are released every Tuesday & Thursday.
The Confident Dollar Podcast
Understanding Roth's
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Roth IRAs & Roth Contributions are an important part of your retirement planning - in this episode I break down the different Roth options along with income limits, tax strategies, etc.
You want to make sure you are diversifying your retirement income for later in life - and a Roth is a great way to be able to do that. You want to understand these!
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00:05 Welcome back to the Confident Dollar podcast. Today we are going to talk about Roth IRAs and why they are important and why you need to understand them and why they can be a really important strategy to be using in your long term retirement planning.
00:20 So I wanted to start by kind of explaining Roth IRAs and how they work. We're going to talk about taxes and how that works with a Roth IRA income limits and different ways that you can do Roth contributions for your retirement savings.
00:35 What specifically is a Roth IRA? So when you have earned income, most people know you have, you know, oftentimes with your job, you have an employer plan, you can be a part of like a 401k or a 403b, but you also have retirement accounts, personal retirement accounts.
00:50 That you can open under your own name and contribute to every year, as long as you have earned income. And there's two options for that.
00:58 You have a traditional IRA or you have a Roth IRA. And the biggest, the big difference between those two is just how they are taxed in the year you contribute.
01:08 And you take that money out in the long run. There are some other differences small differences as far as like what you can use the money for, penalties, RMDs is another difference.
01:18 But overall, the biggest difference that we're going to talk about today is just the way that they are taxed. So a traditional IRA.
01:25 When you contribute to that, let's say for this year, you contribute into your traditional IRA for 2023. When you do your taxes before April, you're going to be able to take that amount you contributed off your income for the year 2023.
01:39 For a Roth IRA, you don't get to do that. You don't get to deduct the amount you contribute in the year that you contribute it.
01:47 So if you contribute to the Roth IRA instead, you put $3,000 in there, you don't get to take that off your income when you do your taxes for 2023.
01:56 But when you get to retirement, when you take that money out since you've already paid income on that money the contributions at least, when you take that money out for qualified distributions and retirement, you don't have to pay income taxes at that point in time.
02:11 For a traditional IRA, you do. So you get the tax deduction now, when you get to retirement, you take money out in retirement with those distributions to live on.
02:20 You are going to have to pay income tax that's going to be taxed at your regular income rate at that time, whatever tax bracket you were in in retirement.
02:28 That's the rate you're going to pay on that, on that money when you take it out for a traditional IRA.
02:33 For a Roth IRA, when you get to retirement, you don't have to pay income taxes on it. So it's, it is essentially a tax free source of income for you in retirement.
02:42 So why is that such a big deal? It would seem like off the bat, you're kind of thinking about that probably evens itself out, right?
02:47 I mean, the biggest difference would be, well, do I pay more taxes now or do I pay more taxes in retirement?
02:52 My tax bracket is lower in retirement. Maybe that's fine. But what are the differences, you know, really the biggest difference and the reason why it's so important to consider is because let's say you're 30 years old, okay?
03:06 You're 30, you are going to retire at 65 and currently you have nothing in a Roth IRA, but after thinking about it and looking into them, you decide to start putting $200 a month into a Roth IRA.
03:18 From the time you're 30 to the time you're 65 and you happen to have annual return rates. You have about 10% every year is what you average.
03:26 Okay? When you get to 65, you will have contributed $84,000 into your Roth IRA. And that amount is what you, you have paid taxes on $84,000 in there.
03:37 You've paid income taxes on that amount of money because you didn't get to deduct it, sorry, in the year you put it in.
03:45 But over that time, as it's been invested, it has grown to over $675,000 is that of growth you've had. So actually total new year count, you have about 760,000, but the amount of money you have is $1,000. The amount of growth after 84,000 of contributions, the amount of growth you've had on that is about
04:02 $675,000 in that account. That amount, when you take that out, you also don't have to pay taxes on that amount.
04:10 So that is a really big benefit of Iran. The growth that you have over that period of time, you do not pay income taxes on.
04:19 And if you start when you're young saving for retirement and investing, you're going to have, even if you don't average 10%, you're going to have a ton of growth because of the length of time you have to invest.
04:31 That that's going to be a lot of money that you save in taxes if you use a Roth IRA. So what are a few stipulations around a Roth IRA?
04:40 How do they work? How can you use them? You know, what are income limits? All of that. So there are basically four different ways.
04:50 And the last two are very similar, but there's four different ways that you can get your money. You can do Roth contributions, basically.
04:57 So the first, what I've been saying is the Roth IRA. That is the first most common, you know, way to get started for having Roth contributions for your retirement plan.
05:07 For the Roth IRA, like I said, this is a personal retirement account that you open if you have earned income.
05:14 You can do this as soon as you have earned income and you can contribute to this. So for 2023 though, there is a limit of $6.
05:21 $6,500 that you can put into a Roth IRA for 2023. If you are over 50, you have a catch up amount of about a thousand of $1,000.
05:30 So you can do 7,500 if you are over, if you are 50 and over into a Roth IRA. The biggest thing to pay attention to with a Roth IRA is that there is a phase out based on your modified adjusted gross income in which you can no longer contribute directly to a Roth IRA.
05:47 So if you are married and you file jointly, your phase out begins at 218,000 and you're fully phased out by 228.
05:54 So if you land in between those numbers, there is an equation in which you can still do a certain amount of a contribution to directly to a Roth, but once you get to 228,000, you cannot contribute directly to a Roth anymore.
06:06 If you are a single filer your phase out starts at 138,000. And you're fully phased out by 153,000. So there are income limits when it comes to contributing directly to a Roth IRA.
06:19 And so this is something, you know, a lot of times young people get, they, I would, my biggest recommendation would be when you're young, get this turned on and get this started because.
06:27 As, as you get older, you're eventually going to make more money. It's going to be more complicated to get Roth contributions for your retirement.
06:34 So it's a really good thing to start young, especially because you have all that time for that compound interest to take effect until retirement.
06:41 So this is a really good thing for young people to get started as soon as they have. Earned income. And then once you start making more money, there are other things you can do.
06:48 Just gets a little trickier. For a, you know, so number two, and the second way you can get Roth contributions for your retirement is within a Roth with Roth 401k contributions.
07:01 This is not offered with everyone's 401k, but I will say I am saying this more and more that employer plans are offering Roth contributions within their 401k, and that is really good news.
07:14 One, because there are no income limits. So if you make too much money to do a Roth IRA, We'll see you next week. But you have off within your 401k at work, you have a Roth contribution options.
07:24 That is fantastic because there's no income limits. So you're not going to have that issue there. The second really good thing about this with Roth 401k is that your contribution limit is a lot.
07:35 Higher. So you can do $22,500 into a Roth, into a 401k. That is your contribution limit for 2023. And if you are 50 or older, you can do $7,500.
07:52 Into a 401k. So obviously you can do a lot more into a Roth 401k than you can a Roth IRA, which has you know, is a very big benefit and really good thing for long-term savings.
08:06 But like I said, they're not offered within every 401k plan. It's going to depend on if your employer has these or not.
08:13 Okay? So if you make too much money, you don't have a Roth 401k option, but you can't do directly to a Roth IRA.
08:20 Another thing that you can do, and you can actually do this regardless, even if you can do Roth contributions. Something that you may consider at some point in your financial planning is a Roth conversion.
08:32 So what this is, is you're not directly contributing to a Roth anymore, but if you have a lot of traditional contributions save for retirement, or a one case that you've now rolled over to IRAs and you have a good amount of those, you know, stockpiling, but you also have a lot of plenty of time until
08:51 retirement or the biggest thing I would say, there's like a five year rule when it comes to a Roth IRA.
08:55 That's kind of the one thing to pay attention to, but if you have more time than that. It might be a good idea to do a Roth conversion and this would just be taking a portion of that traditional IRA and converting it to a Roth.
09:12 So what happens when you do this is whatever that amount is that you're converting to $5,000 this year from your traditional IRA to a Roth IRA, you are going to pay taxes on that $5,000 this year and then it goes into the Roth IRA and then it will grow from there.
09:30 So that's called a Roth conversion and you can do that. It does not have income limits so that is something that you can do depending upon how much Roth contributions you have for retirement.
09:42 This might be a strategy you want to utilize, but it is important to consider the tax implications because depending on how much you convert, obviously in that year you're going to pay taxes on that.
09:51 So does it make sense, you know, there's a kind of some math you need to do on the back end to see if it even makes sense to do that conversion for the long run for what the benefit may be in retirement versus just keeping it in traditional and not paying taxes on it now.
10:05 So but that is, another option and a strategy you can consider to get Roth contributions, you know, for, for later on for retirement.
10:15 And then very similar to that is so it essentially is a Roth conversion, but it is called a backdoor. Roth.
10:24 And this is a better strategy actually, if you don't have any IRA money. So you've no traditional IRA money. If all, most of your retirement accounts are still in a 401k and you make two much money to do Roth contributions.
10:43 The simplest version of this is, is this scenario in which all of it's in a 401k. You make too much to do Roth contributions directly.
10:49 So you can do what's called a backdoor Roth, which means you contribute a non-deductible. Contribution to a IRA. So you're actually not taking that deduction anyways, because you make too much money for the deduction in an IRA, and then you're immediately contributing sorry, converting that into a Roth
11:08 IRA. So instead of taking money that's already been invested for that Roth, you, or just, it's like this immediate transaction that's happening, which makes it a little bit different than that Roth conversion, but is essentially the same idea and this is another way that high earners are saving Roth
11:26 contributions for their retirement. So, those last two strategies definitely are going to need a little more consulting and a little more thought especially around the tax applications of how that may work and what that means for you, but they are strategies that you can utilize in order to get Roth
11:46 contributions. So, again, just to reiterate, I would say that for young people, especially before they are out of that income limit, this is like my first often times my first recommendation is like, okay, like, if you ever earn an income open up a Roth IRA, because you just have so much time to take
12:08 advantage of that tax-free growth, basically, for your retirement. And a lot of times when you're first getting started a job anyways, it doesn't really, you don't really need that tax deduction for the traditional IRA anyway, so you're not getting messed up by not having- having that.
12:22 So it's a really good thing to get started when you are younger, and I would say oftentimes, you know, one of the main accounts I would recommend for people to open in most situations.
12:32 And then like I said, when you start making too much money then you have to get a little bit more creative and figure out how you're going to keep doing that.
12:39 It is a really important type of retirement income to save and because, you know, when you get to retirement, if you do all traditional contributions and that's the only type you save then when you get to retirement, the only thing you have is taxable income.
12:55 So you want to have some tax diversification in retirement which is, you know, where this Roth can really come in handy.
13:02 So hopefully that helps kind of explain a breakdown of Roths and how you can start utilizing them in your financial planning.
