So what about that IRA family? While the TSPs and 401k may seem like practical, simple folk. That IRA family can be as easy to comprehend as a dumpster fire. So today I thought I’d take on the stink, smoke, and confusion and make some sense of the IRA family. First off, remember all IRAs have the same allowed contribution amounts, that’s $6,000 a year, plus an extra $1,000 a year if your age 50 or over. Yes, those numbers are different than the TSP and 401k families. The IRA family is completely separate. And unlike real life, you can hitch yourself to a member of the IRA family AND a member of the TSP or 401k family at the same time, up to the full limit for each.
The first thing an IRA will wants to know about you is how much money do you make. If you’re single and make less than $76,000 a year or married making less than $125,000 a year you can contribute to a Traditional IRA.
Like other retirement plans with a first name Traditional, you don’t pay tax on your contributions when you make them or while your money grows. Your taxes are deferred until you pull it out in retirement. Many people are in a lower tax bracket when they retire, so they pay less taxes overall than if they had paid tax on those contributions while they were still working. But there’s a catch. If you make more than the income limits you cannot deduct contributions. You can court the Non-deductible Traditional IRA but is no great catch. Your contributions are non-deductible which means you will have to pay income tax on your contributions when you make them. The earnings will grow tax deferred. But when you pull it out, those earnings are taxed as regular income. So why would anybody swipe right on that IRA? Sad to say, they often are just using it to get in the family. Then dump old Non-deductible to hit on other hotter sibling Roth IRA, which I’ll get to in a little bit.
Like those other Roths, Roth IRA is tax-free in retirement. You need to leave it in the account for 5 years and be over 59 ½ years old to avoid taxes and penalty though. And what does the IRA family want to know before you start dating one of their own? How much money do you make?! If you are single and earn more than $140,000 or married earning more that $208,000 dollars you can’t contribute directly to a Roth IRA at all. You can’t just go in the IRA family front door, drop to one knee, and propose to Roth. Heartbroken? Well…there is always the backdoor.
The IRS does permit you to rollover money from other qualified retirement plans into a Roth, you just have pay to income taxes on it if you haven’t already. You can choose to rollover contributions from the Non-deductible account into a Roth account and it is transformed into tax-free forever savings. If your savings grew while it was in a non-Roth account, you would need to pay tax on just that increase at the time of the rollover. Some 401k plans allow you to rollover from a Traditional 401k to a Roth 401k. TSP does not allow you to transfer funds from Traditional TSP to a Roth TSP. But you can rollover from any Traditional 401k, Traditional TSP, Traditional IRA or Non-deductible Traditional IRA into a Roth IRA. You’ll pay some taxes on the money you rollover. But after that all the earnings are tax-free.
Depending on the rules of your retirement account, to can transfer or rollover your savings from one to another. You may do this to consolidate your savings in one place. Or you may decide to roll your savings over from a Traditional account to a Roth account to pay some tax now so you can save on taxes in retirement. Check the rules for your specific plan.
Still wondering if a Roth might be the one for you? Tune in next week as we look at some examples and things to consider as you make your big decision.
Kathleen Cannon:
Hello, and welcome back to the podcast. Last week, we got to know Roth a little better, you may remember that I compared Roth to a first name of a retirement savings account. And that if your retirement account was given the first name broth, that means that you paid income tax on your income before it went into your Roth 401k Roth tsp or Roth IRA. After that, it's all tax free. As long as you wait five years since your first contribution, and you're over 59 and a half years old before you start withdrawing your earnings. Your earnings grow tax free. And since you paid tax on the contributions upfront, that's now tax free to Oh, your retirement plan doesn't have a first name Roth. Well, you get a nice break and don't pay any taxes on those contributions upfront. But every dollar you pull out of a traditional account in the future, will be taxed at your regular income tax rate. You may remember from last week, that the Roth's also have last names or family names like 401 K, tsp, or IRA. The tsp and 401 k families are pretty straightforward. We talked about how you can designate all or part of your contributions to your Roth tsp if you're military or a federal employee, or a Roth 401k. As long as your employer offers it. You can contribute up to $19,500 a year, plus another 6500 a year if you're 50 or over. And I did some serious foot stopping to remind our military service members to make only Roth tsp contributions if they're earning tax free combat pay. So what about that IRA family? While the TSP s and 401 K's may seem like practical, simple folk, the IRA family can be as easy to comprehend as a dumpster fire.
Unknown:
So today, I thought I'd take on the stink, smoke and confusion and make some sense out of the IRA family.
Kathleen Cannon:
First off, remember all IRAs have the same allowed contribution amounts that $6,000 a year plus an extra 1000 a year if you're age 50. year over. Yes, those numbers are different than the TSP and 401k families. The IRA family is completely separate. And unlike real life, you can hit yourself too a member of the IRA family and a member of the TSP 401k family at the same time, up to the full limit for each. So let's say you're intrigued by this IRA family and want to know more. Well, one thing you need to know about the IRAs is that they are very materialistic. The first thing an IRA will want to know about you is how much money do you make. If you're single and make less than $76,000 a year or married making less than 125,000 a year, you can do a traditional IRA. Like other retirement plans with the first name traditional, you don't pay tax on your contributions when you make them or while your money grows. Your taxes are deferred until you pull it out in retirement. Remember, traditional IRA taxes are deferred but eventually you pay regular income taxes on everything. Many people are in a lower tax bracket when they retire. So they pay less taxes overall than if they had paid the taxes. Those contributions while they were still working. Traditional is sounding pretty good. And it often is. But there's a catch. Remember what I said about this IRA family, it's all about the money. And if you make more than the income limits, you cannot deduct contributions. But you can court the non deductible, traditional IRA, no matter how rich you are. Sadly, though, this windbag IRA is no great catch. Your contributions are non deductible, which means you will have to pay income tax on your contributions when you make them. The earnings will grow tax deferred, that is, while it sits in the account, it's not taxed. But when you pull it out, those earnings are taxed as regular income. Well, that doesn't seem so bad. At least you delay the taxes and those earnings will grow faster. Yeah, but what if you just stayed an untethered bachelor and invested directly in the market, all those retirement plan families be damned, you would pay tax on your income before you invested it somewhere else. As it grew, you'd pay income tax on earnings that you received along the way, like dividends or bond interest. But as the value of your investment grew, like the increase in the prices of your stocks or mutual funds, you wouldn't pay tax on that growth until you sold it. And then you would only pay capital gains tax on the profit. And that's the key that capital gains tax is less than the income tax, you would have paid on that non deductible traditional IRA. So yeah, while you could put off paying some of that tax for a while on the non deductible, traditional IRA, in the end, yeah, you'll pay more tax than if you just invested it yourself. They can put lipstick or a tux on it, or give it a long and pretentious first name. But that non deductible traditional IRA is a real letdown once you pick up the veil. So why would anybody swipe right on that IRA? Well, Sam, sad to say they are often just using it to get in the family. Then they dump old nondeductible to hit on their hotter sibling Roth IRA, which I'll get to in a little bit. Like I've been saying, there's a lot going on in this IRA family. And maybe you just cut your first glimpse of that seductive Roth IRA over there. You may remember, like those other Roth's Roth IRA is free, that is tax free in retirement. With any Roth you might choose, you have to pay income tax on your contributions upfront. But after that, your earnings are all tax free forever. Like other Roth's, you need to leave it in the account for five years, and be over 59 and a half years old to avoid taxes and penalties, though it may be a Roth, but it's still in the IRA family. And what does the IRA family want to know before you can start dating one of their own? How much money do you make? If you're single and earn more than$140,000? Or married, earning more than $208,000? You can't contribute directly to a Roth IRA at all. You can't just go in the IRA family front door drop to one knee and proposed to Roth heartbroken. Well, there's always the backdoor. a backdoor Roth, is that legal? Yes. And it's not nearly as Alissa does it sound. As I just mentioned, if you make too much money, you can't contribute directly to a Roth IRA. Anyone with earned income can contribute to a traditional IRA. It just may be non deductible. But the IRS does permit you to rollover money from other qualified retirement plans into a Roth. You just have to pay income taxes on it if you haven't already. Remember that non deductible traditional IRA. nobody seemed interested in before. You can choose to rollover those contributions from the non deductible account into a Roth account, and it is transformed into tax free forever savings. If your savings grew while it was in the non Roth accounts, You'll need to pay tax on just that increase at the time of the rollover. But after that, any increases tax free. Again, the family sets the rules, so you have to check with each one. Some 401k plans allow you to rollover from a traditional 401k to a Roth 401 K. tsp unfortunately does not allow you to transfer funds from traditional tsp to a Roth tsp. But you can rollover from any traditional 401k traditional tsp traditional IRA, or non deductible traditional IRA into a Roth IRA. You'll pay some taxes on the money rollover. But after that, again, all the earnings are tax free. Now you may be thinking, Oh my God, my head's about to explode. Just throw me on the dumpster fire. I feel your pain. Hang in there. And let's just go over the big picture one more time. If you put your savings in a retirement plan with the first name Roth, you pay income tax upfront, but then in retirement, all your withdrawals will be tax free. If your plan has just traditional for a first name, you don't pay any taxes up front. But you must pay income tax on all your withdrawals in retirement. It's pay Uncle Sam now or pay him later. And if you contribute to the ugly duckling, non deductible traditional IRA, you pay tax on your contributions when they go into the IRA. And you pay income tax on any growth or earnings when you withdraw them in retirement. You can contribute up to $19,500 a year to the 401k or tsp family 26,000 total if you're 50 or older. You can also contribute 6000 a year to the IRA family or 7000 total if you're 50 year older. And remember, you can contribute the full amount to a 401 tsp as well as the full amount to an IRA family if you want. Depending on the rules for your retirement account. You can transfer or rollover your savings from one plan to another. You may do this to consolidate your savings in one place. Or you may decide to roll your savings over from a traditional account to a Roth account to pay some tax now so that you can save on taxes in retirement. Remember, you need to check the rules for your specific plan.
Unknown:
still wondering if Roth might be the one for you. Tune in next week and we'll look at some examples and things to consider as you make your big decision.