As we start a New Year and people I’ve been getting more questions about Roth retirement contributions. So I’m using the next few episodes to introduce you to Roth. Think of Roth as a retirement plan’s first name. Although Roths share the same first name, they belong to different families. And lthese families have their own family rules and norms. Common Roth last names are Thrift Savings Plan (TSP), 401(k), and Individual Retirement Account (IRA). So what’s so special about Roth? You pay income tax on your contribution’s BEFORE you put them into a Roth retirement account. All the money you earn on those contributions over the years is all yours, tax-free when you pull it out, as long as you meet a couple of requirements. If you have to pay taxes now, why would get hitched to a Roth? Look at what tax bracket you are in now. What tax bracket you will you be in when you retire? Generally, if you are earning less money now than in retirement, it pays to choose Roth and pay less tax overall in your lifetime. If you're earning more now, it often pays to choose one of Roth’s traditional siblings. To some extent you need a crystal ball to predict the future. I’ll cover more details and examples in another episode. There is a special rule for our military servicemembers contributing tax-exempt combat pay to TSP. Put it in a ROTH TSP. You won’t pay tax if you use it to make contributions to a Traditional TSP account. BUT when you take that money out in retirement, you will be taxed on your contributions. If you will be earning tax exempt combat pay make only ROTH TSP contributions with that pay, not Traditional TSP contributions.
How long until you tap your retirement savings? Roth can be fun, but it could be a costly mistake if it’s a one-night stand. You have to wait for 5 years from your first contribution to a Roth and be at least 59 ½ years old when you begin withdrawals to stay tax and penalty free. There are just a few exceptions. Pull out early, and you’ll pay income tax on the earning and an additional 10% penalty for an early withdrawal. An early breakup is gonna cost you.
Also, Roth can be a faithful partner in old age. The IRS will require you to begin taking withdrawals from traditional retirement accounts at age 72. Your Roth retirement savings can stay invested and grow with you until you decide.
What about those last names? 401k plans are sponsored by your employer. They can offer a traditional 401k and a Roth 401k if they want. TSP follows the same rules as the 401k family. TSP does offer both Traditional TSP and Roth TSP. Your combined yearly contributions don’t exceed the limit, which in 2021 is $19,500 a year, plus an additional $6,500 a year if you are age 50 or older.
Roth IRAs? Your employer has nothing to do with it. You would open an IRA on your own. The IRA family is not tied to the TSP or 401k families in any way. For 2021, your combined yearly IRA contributions (whether Roth and Traditional) ca be $6,000 per year, plus an additional $1,000 if you are 50 or older. There is no rule baring you from contributing your full $19,500 total to the Roth and Traditional TSP family as well as $6,000 total to the Roth and Traditional IRA family. So to wrap things up, remember if your retirement plan has a first name of Roth, you pay income tax up front when you contribute, and as long as you follow the family rules, all your withdrawals are tax-free in retirement. If your retirement plan has a last name of TSP or 401k, you cam make contributions up to $19,500 a year, plus $6,500 a year 50 or over. through your employer. If your retirement plan has a last name IRA, you set the account yourself and can contribute up to $6,000 a year, $7,000 50 or over. And yes you can contribute the max amount to the TSP/401k family and the maximum amount to the IRA family at the same time.
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Welcome to the Money Pilot Financial Advisor Podcast, where you team up with money violin founder, former Army helicopter pilot and your host, Jason cannon, you put your money where your heart is. Together, we'll tackle issues big and small so you can take charge and lead your financial life.
Kathleen Cannon:
Welcome back to the Money Pilot Financial Advisor podcast. As we start a new year, and people are thinking about the upcoming tax season, I've been getting more questions about Roth retirement contributions. It's no wonder since Roth retirement savings are like regular retirement savings in some ways, but with different rules. Let's face it, it can be confusing and a little scary. So I'm using the next few episodes to introduce you to Roth, and help you explore whether starting a relationship with Roth might be a good match for you. So let's get to know Roth. Think of Roth as a retirement plans first name, like a Susan or an Eric, there are actually quite a few Roth's out there, and they all share some special Roth personality traits. But although Ross share the same first name, they belong to different families. And like real families, these families have their own rules and norms, comment common Roth last names, our Thrift Savings Plan, tsp 401k, and individual retirement account or IRA. Just like Sally Smith, Sally Fernandez, Eric Smith, and Eric Hernandez are all different people, and don't like to be mixed up. Roth tsp is different, and operates under different rules than a Roth IRA, or a traditional tsp or traditional IRA. So what's so special about Roth, the big thing to know about anything named Roth is that you pay income tax on your contributions before you put them into a Roth retirement account. Then after that, it's all tax free for ever. All the money you earn on those contributions over the years is all yours tax free when you pull it out. As long as you meet a few of the requirements that I'll cover in a bit. I don't have to pay taxes on anything. Now if I choose one of Ross brothers or sisters, and I know that if I invest less for retirement now because I have to pay tax on it first, I'll have a lot less saved when I get to retirement. So why would I get hitched to a Roth? Great question. Uncle Sam is going to get his tax money one way or the other, either now or later. An important question to ask yourself, though, is how much tax will I pay now compared to how much tax I would have to pay when I pull it out later? The way to compare this is to look at what tax bracket you're in. Specifically, what is your federal tax rate this year? That is what percentage of your contributions will you have to pay tax on today with Roth? How does this compare to the tax rate you would pay on that income when you retire? Generally, if you're earning less money now and are in a lower tax bracket now than in retirement, it pays to choose Roth contributions and pay less tax overall in your lifetime. If you're in a higher tax bracket now than in retirement, it often pays to choose one of Roth traditional siblings. Of course, there's more to it than that, and to some extent, you need a crystal ball to predict the future. But don't let that stop you from considering Roth. I'll cover more details and show some examples of how a Roth might be a good match in another episode, including transfers and the backdoor Roth you may have heard of. It sounds a bit sneaky and CDI admit perhaps like a secret Las Vegas wedding. But like a Vegas wedding, even when with Elvis, it's completely legal. And if it's a good match in the first place, it can lead to a long and happy relationship. Again, we'll explore some scenarios in detail Next week, I want to just take a minute out to talk about one special rule for our military service members who might be contributing tax exempt combat pay to tsp. Because that pay is tax exempt when you get it, you don't pay taxes on it when you receive it, put it in a Roth tsp, and you won't pay any taxes on the earnings either. It's everything you put in, and everything you pull out in retirement is all tax free forever. While Roth tsp is so generous, its stingy traditional tsp sibling is not. You won't pay tax on the tax exempt pay when you use it to make contributions to a traditional TSP account. But when you take that money out in retirement, you will be taxed on your contributions, then you'll still get the earnings that those contributions made. That is the growth of your investment tax free, but you'd pay income tax on those and I'm err, quoting here tax exempt contributions. If you put it in a traditional tsp, I can't foot stomp this hard enough. If you will be earning tax exempt combat pay, make only Roth tsp contributions with that pay not traditional tsp contributions. There are no good reasons to make tax exempt contributions to a traditional TSP account. Okay, I love about that special rule. And back to getting to know Roth. Another consideration for everyone getting to know Roth is how long is it until you need to tap your retirement savings. Roth can be fun, but it could be a costly mistake. If it's just a one night stand. You have to wait five years from your first contribution to a Roth before you can withdraw any growth and earnings tax and penalty free. And you have to be at least 59 and a half years old when you begin withdrawals to stay tax and penalty free to there are just a few exceptions to this penalty. Other than that, pull it out early, and you'll pay income tax on the earnings and additional 10% penalty for early withdrawal. It could be a good marriage if Roth is the one, but an early breakup is gonna cost you. Also, Roth can be a faithful partner and old age, the IRS will require you to begin taking withdrawals from a traditional retirement account at age 72. it dictates the minimum amount you must take out and pay regular income taxes on each year. Your Roth retirement savings can stay invested and continue to grow with you even after age 72 until you decide to begin withdrawals and how much to take out. Remember, the longer you can leave it, the more it can grow. And those earnings will all be tax free when you need them. Okay, I've covered some of the key ways everything with the first name Roth are the same. What about those last names like IRA, 401k, and tsp? How do these family routes affect Roth, kinda like the families of Romeo and Juliet. These families have some hard and fast rules. Not everyone can join every family and some families will never spawn a Roth. Let's start with 401 K. The 401 family plans are all sponsored by your employer. They can offer a traditional 401k and a Roth 401 k if they want, but they don't have to. You can only contribute to a Roth 401 k if your employer created one in the first place. tsp follows the same rules as the 401k family. Fortunately for our military and federal employees, tsp does offer both the traditional tsp and Roth tsp for you to consider when your employer offers it, you can make all or some of your contributions to Roth, as long as your combined yearly contributions don't exceed the limit, which in 2021 is $19,500 a year plus an additional 6500 a year if you're age 50 or older.
Unknown:
What about Roth IRAs
Kathleen Cannon:
ah Ira family is a whole nother kettle of fish. Remember, the eye and Ira stands for individual, so your employer has nothing to do with it. You would open an IRA on your own, not through your employer, the IRA family plays by its own rules, and it's not tied to the TSP or 401 k families in any way. The IRA rules for 2021 limit your combined yearly IRA contributions, whether Roth or traditional to $6,000 per year, plus an additional $1,000 if you're 50 or older. The rules for Roth IRAs and traditional IRAs are complex. So we're gonna dive in and go through those details. And our next podcast episode may be wondering, can I have an open retirement savings marriage? Yes, if you meet each family's requirements, you can hook up with all of them at the same time, or some one year and others the next. There's no rule barring you from contributing your full $19,500 total to a Roth and traditional members of the TSP family, as well as$6,000 total to the Roth and traditional members of the IRA family. You might not measure up to the rules for each and every one of these every year. But we'll talk in more detail about what it takes to be a successful suitor and how to decide which ones are a good match for you over the next two weeks. So to wrap things up. Remember, if your retirement plan has the first name of Roth, you pay income tax upfront when you contribute. And as long as you follow the family rules, all your withdrawals are tax free in retirement. If your retirement plan has a last name of tsp or a 401 K, you can make contributions up to $19,500 a year plus 6500 a year if you're 50 or over, contribute through your employer and it's up to your employer whether they offer a Roth option. If your retirement plan has the last name IRA, you set the account up yourself and can contribute up to $6,000 a year, or $7,000 a year if you're 50. year over this IRA family has Roth traditional, and a third offspring call the non deductible traditional IRA more on him and the rest of the IRA family next week. And yes, you can double dip without shame and contribute the maximum out to the TSP 401 k family and the maximum amount to the IRA family at the same time. I'm just not sure I'd rub that in the patriarchs face. I hope you've enjoyed your first introduction to Roth. We'll give you another chance to get to know each other better next week. And who knows maybe you'll find the one.
Unknown:
Thank you for joining today's podcast like to find out more, visit us at www.moneypilotadvisor.com dot com. Let's team up and land your financial life.