Today, Paula Christine is joined by Certified Financial Planner Diane Winner, from Bank of Ann Arbor, to explain Roth IRA's.
Diane explains the benefits of Roth IRAs - tax deferred growth and withdrawals - along with the restrictions on taking out qualified distributions.
We cover contribution limits, and the differences between contributing to a Roth IRA vs other retirement vehicles.
Turns out, Roth money can be used for purposes other than retirement; Diane explains. We also talk about Roth conversions, what they look like, and why they may not be for everyone.
Want to know more?
Reach out to Diane Winner at dwinner@boaa.com
To Paula Christine at Paula@PaulaChristine.com
Or visit our website: https://paulachristine.com/
Paula: Hi, I'm Paula Christine. Welcome to Beyond the Paycheck. Living paycheck to paycheck and struggling to get ahead can really suck. What if you could take control of your money and have the life that you dream about? It can happen with knowledge and commitment. That is my goal. To provide you with the knowledge to take control of your money. It's up to you to make the commit.
So a lot of people have asked me in the past, what's a Roth IRA? What's a traditional IRA? What's a 401k? So I've asked Diane Winner, who's a certified financial planner with LPL to join us today, to talk about what a Roth IRA is. Welcome. Diane.
Diane: Thank you, Paula.
Paula: Let's start with what is a Roth IRA?
Diane: Well, a Roth IRA is a personal,retirement savings plan. You access it after 59 and a half.
Paula: So why do I wanna contribute it? What is the major benefit of a Roth versus anything else?
Diane: I will tell you. That's one of my favorite retirement plans is a Roth IRA. So Roth IRA contributions that you put into it, it's like a savings account. We've already paid taxes on it. It grows tax deferred. And at retirement it's completely a hundred percent tax free.
Paula: Do I have any rules or limits or anything that I have to worry about?
Diane: Yeah. Rules that you have to be aware. Is that you can only contribute up to $6,000 into a Roth IRA.
If you're over the age of 50, you get to make a catch up contribution of an additional thousand. But the key is you have to have earned income in order to make that contribution. So if you only have made $3,000 in one year, for example, you could only contribute $3000 into a Roth. IRA.
Paula: So I have a 401k work right now at my employer. Can I do my work 401k, and a Roth IRA?
Diane: Depends. Contribution to a Roth IRA depends on your filing tax status. If you are single or married and really your modified adjusted gross income. In other words, your taxable income. You can contribute to a 401k and a Roth IRA. As long as you're not phased out, meaning you've made too much money.
So sometimes though, the other thing to look at is in your 401k. You may be able to utilize, or your company may have a Roth component, within your 401k that you're not subject to income limitations. So theoretically you could put all of your contributions into a Roth IRA in your 401k, and not have to worry about income. But most people like to utilize their 401k to reduce their taxable income.
Paula: I'm gonna break that down a little bit. I have a 401k at work and with my 401k, I may have an option of doing a traditional 401k or a Roth 401k. So if I do either the traditional or the Roth, I don't have any income limits. I have contribution limits, but not income limits. But if I don't have a Roth 401k option through my employer. I can do my traditional 401k and possibly contribute to a Roth IRA if I'm under a certain income limit. Are there any other rules that I should know about?
Diane: Absolutely. So to be eligible for qualifying distributions. And what that means is to be able to take a distribution from your Roth IRA income tax free, you have to meet a five year holding period and be over 59 and half.
So if you make a withdrawal prior to 59 and a half, you're gonna be subject to a 10% penalty, as well as taxation on the investment earning.
Paula: Can I use the money for anything else other than retirement?
Diane: Yes, you can. So any withdrawals made because of disability, if you're a first time home buyer, and as a first time home buyer, you can only take up to $10,000.
It's a lifetime limit from all IRAs. It doesn't matter if it's a Roth or traditional. And any death beneficiaries. So if you inherit it a Roth IRA, you could take money out of that and not pay the penalty. So those types of withdrawals avoid your taxes and the 10% penalty.
Paula: So the big advantage that I'm getting from this conversation is that the Roth IRA allows you to put money away for retirement.
When the money comes out, it comes out tax free, grows tax deferred. I have to hold it for five years. And there are other things that I can use it for, like disability, to purchase a home. Am I correct?
Diane: Yes, you are.
Paula: Okay. So let's say that I never saved in a Roth IRA and now I'm getting older. And I hear this term all the time. Roth conversion. Should I convert my traditional IRA money or my 401k to a Roth? How does that work?
Diane: It's called a Roth IRA conversion. You're taking money that you put aside in a retirement vehicle that you did not pay taxes on. When you convert it to a Roth, you're taking that money and moving it into a vehicle tha,t well, they both grow tax deferred. But you down the road will not pay taxes on your Roth IRA versus your traditional.
When you make that conversion, though, it's a taxable event to you. Uncle Sam gets their taxes one way or the other. So you will pay taxes to move that into a Roth IRA bucket. But the advantage to you is down the road. When you pull that money out at retirement, it's a hundred percent tax free instead of a hundred percent taxable.
Paula: Is that a right decision for everybody?
Diane: No, it's not right for everybody. It depends on personal goals and tax tolerance. Cuz remember Roth IRA conversion is a taxable event and people do it for very specific goals. When you make that conversion, yes, you pay the taxes. It will still grow tax deferred and it's a hundred percent tax free in retirement.
The nice thing about utilizing a Roth IRA conversion is that you're not subject to required mandatory distribution like you are with a traditional IRA at age 72. You can also then leave a tax free inheritance to beneficiaries. And you're not subject to income tax phase out. So you need to remember though, when you make that conversion, that you're paying taxes.
So you may not wanna convert a large sum at any given time because it can push you in another tax bracket. But if you're in a low tax bracket today, it can make sense because your tax bracket may change down the road.
Paula: So if I understand correctly, that if I'm gonna consider a Roth conversion, I should reach out to my tax person and a certified financial planner to help me make that decision.
Diane: Absolutely.
Paula: Seems to me, it's probably a bit confusing and I'm sure that somebody can put themselves in a new tax bracket if they're not paying attention to what they're doing, they don't have all the rules.
Diane: Correct.
Paula: From what I understand in this conversation, Diane, is that the Roth IRA has some huge tax advantages in the long term when you're saving for retirement. Cuz when you withdraw, it'll be tax free, grows tax deferred and it's tax free during retirement. But you really want to sit down and talk with a certified financial planner or a tax person to determine is the Roth right for you, even though it does have those advantages. Is it right for you at this time in your life?
So Diane, if anybody wants to get ahold of you to talk with you about that decision, how can they reach.
Diane: I can be reached at dwinner@boaa.com like a lottery winner, dwinner@boaa.com. Which stands for Bank of Ann Arbor.
Paula: So I know Diane as being a financial planner, that you do have a disclosure.
So I'm gonna go ahead and read that. Diane Winner, her securities and advisory services are offered through LPL financial, a registered investment advisor and broker dealer. Member FINRA SIPC. Thanks. Diane.
Diane: Thank you Paula, for having me.
Paula: If you have any questions or would like to reach out to me, feel free to email me, Paula@Paula, christine.com. Or check out my website, Paulachristine.com.