Investment Strategies

Happy Birthday to You, Roth IRA!

author photo

by Alli Thomas

May 8, 2018

Where were you twenty years ago? Saving Private Ryan was the top-grossing film, ER was the most-popular show on television, retired professional wrestler Jesse Ventura was elected governor of Minnesota, MP3 players hit the market for the first time…and the Roth IRA was born, changing the landscape of retirement savings forever.

Tonight We’re Gonna Party Like It’s 1998

There are many reasons to celebrate the Roth.

The Roth’s main allure is that anyone who earns income can open one, and contributions to it, while not tax-deductible, grow tax-free. Withdrawals of Roth contributions are also tax- and penalty-free at any time.

For 2018, you can contribute up to $5,500 to a Roth, or up to $6,500 if you’re age 50 or older.

If you’re married and file taxes jointly, you can establish a Roth for a non-working spouse—effectively doubling the amount you can contribute within a tax year. Over time, this can add up to significant savings for you and your spouse.

Who benefits from a Roth? People who believe they will be in a higher tax bracket at retirement than they are now. Some financial professionals even call the Roth “tax insurance” because once you’re invested in one, you’ll never have to pay taxes on contributions (or, in most cases, earnings) again.

If you’re concerned about estate planning, a Roth is a nifty way to pass on your assets to your beneficiaries, who will receive them tax-free. Roth IRAs are not subject to probate, which means your heirs will enjoy speedier access to the funds.

If you are under age 59 1/2, you can withdraw up to $10,000 over your lifetime from your Roth to cover qualified first-time homebuyer costs without incurring the 10% early-withdrawal penalty or taxes (on contributions or earnings), provided that at least five years has passed since your initial Roth contribution. 

You don’t even have to be a true first-time homebuyer to take advantage of this provision. Provided that you (and your spouse, if you’re married) have not owned a home in the two years prior to the purchase of your new home, your Roth withdrawal will be tax- and penalty-free!

You can also take a penalty-free early withdrawal from your Roth for qualified education expenses for yourself, your spouse, or your children or grandchildren. If you withdraw Roth earnings, however, you will have to pay taxes on them. Withdrawal of Roth contributions is always tax-free.

Unlike a traditional IRA, a Roth doesn’t have age limits on contributions. Nor is the Roth subject to required minimum distribution (RMD) rules once you reach age 70 ½.

Would you like to learn more about retirement planning? Attend our FREE online workshop.

Learn More

Sneak in the Back Door

Despite its many attractive features, the Roth does have one major limit: you may earn too much to contribute to one. Luckily, there is a loophole around this limitation.

If you are single, your eligibility to contribute to a Roth begins to phase out if you earn more than $120,000 ($189,000 if you’re married and file jointly). 

The loophole? You can convert a traditional IRA to a Roth IRA, no matter how much you earn, through a back-door conversion.

Of course, since Uncle Sam always has his hand out, you’ll have to pay taxes on the amount of conversion.

Another thing to remember: the portion of back-door funds in your Roth are not considered contributions. If you’re under age 59 ½, you’ll have to wait five years from the date of conversion to withdraw them penalty-free.

Intrigued by back-door conversions? Here are a few more things to note: 

  • Consider doing a back-door conversion in early retirement, when your earned income decreases, but before you must start taking RMDs from your traditional IRA. 
  • A back-door conversion could push you into a higher tax bracket in the year the conversion is done, which could result in heftier Medicare premiums and higher taxes on your Social Security benefits. Doing multiple back-door conversions over the period of several years can help spread out your tax liability.
  • While back-door conversions are permitted now, the IRS has not issued official guidance on them. So this loophole may not be around forever.

Although back-door conversions may sound simple, they can be difficult to navigate on your own. That’s why we recommend that you get detailed guidance from one of our financial professionals. Leave a comment below or click on the Ask a Question link from the menu in the upper right corner of this page to start a no-cost, no-obligation conversation with us!

Alli Thomas

Alli Thomas has worked in the financial services industry for nearly 20 years, with a focus on retirement-related investing. She began her career as a FINRA-licensed participant-services call-center associate at Vanguard, and then moved to Principal Financial Group, where she worked closely with employers, assisting with retirement plan set-up and design, selecting appropriate plan investment offerings, and maximizing employee participation through targeted education campaigns and enrollment meetings. Alli has also worked as a qualified 401(k) administrator and registered investment advisor for several small investment firms. She now writes about all things investment- and finance-related, leveraging her extensive experience and passion for retirement planning to help investors make well-informed financial decisions.

This field is required

2 Responses

  1. Freddy Cupen says:

    Excellent information.
    How at age 68 canI take advantage of a Roth IRA ?