To use or not use a Roth IRA?

A simple but common question we get from even the wealthiest individuals in the most complex situations.

The difference between a Roth IRA and a Traditional IRA is:

• Roth IRA contributions are made after-tax

• Traditional IRA contributions are made before-tax

• Roth IRA contributions are invested after-tax, grow tax-free, and are withdrawn tax-free.

• Traditional IRA contributions invested before-tax, grow tax-deferred, and we pay ordinary income tax on withdrawals.

• Roth IRAs - think pay taxes today

• Traditional IRA - think pay taxes in the future

• The same applies to pre-tax 401k contributions vs. Roth (after-tax) 401k contributions.

So how do you know which one makes more sense for you?

And what about “Roth Conversions” or the “Backdoor” Roth IRA contribution?

In the future, will you be in a higher or lower tax bracket than you are today?

This simple question can help you determine which account is best for you.

If you’ve reached GM, Executive GM, or Partner status and are 45 or older, you’re likely pushing the top income tax brackets and will likely be in a lower tax bracket when you retire.

And pre-tax or Traditional IRA contributions are likely your best option.

Because you will likely be in a lower tax bracket during retirement when you take withdrawals and pay taxes than you are today.

If you haven’t reached your income-earning potential and you’re on the rise, using a Roth IRA now and paying taxes today might be the way to go.

Mistake Number 1: The wrong account. Choosing the wrong account based on your specific situation could cost you a lot of money accrued from unnecessary taxes on future investment gains.

Roth Conversions for this same person. GM, Executive, Partner, 45+

Roth Conversions involve intentionally withdrawing funds from retirement accounts, paying taxes, and moving the money into a Roth IRA.

If you’re in the top tax brackets today, you likely want to wait until you have an opportunity in the lower tax bracket to execute Roth conversions.

Typically, an excellent time for Roth Conversions is the years between retirement and when the government mandates withdrawals, called Required Minimum Distributions.

RMDs begin at age 72 to 75, depending on your birthdate.

Say you retire at age 60 and RMDs start at 73; you’ve got 13 years to be in a lower tax bracket and formulate a plan with your advisor to convert pre-tax accounts to Roth accounts.

Roth Conversions while you’re still working will cost you taxes at your current tax bracket, and it will take longer for the investment to recoup the taxes paid.

IMPORTANT NOTE: If you’re under age 59.5 and considering Roth conversions with your advisor, you MUST pay the tax from separate cash. If you pay taxes on withholding, the conversion is considered a distribution, and you will pay a 10% penalty.

Mistake Number 2: Roth Conversions at the wrong time. Executing a Roth Conversion strategy at the wrong time, simply because you heard it was a good idea on YouTube, can cost you tens, if not hundreds, of thousands of dollars over your lifetime. Executing a Roth Conversion strategy at the correct times can help you keep tens, if not hundreds, of thousands of dollars for spending during retirement.

Backdoor Roth IRAs

For the same person. GM, Executive GM, Partner…

A Backdoor Roth IRA is only necessary if you have already making max annual contributions to your current 401(k) plan.

That means $23,000 per year for those under 50.

$30,500 for those ages 50-59.

And starting in 2025, those ages 60-63 get a max limit of $41,250.

If you are not already hitting these annual max-outs, you don’t need to worry about a Backdoor Roth IRA.

If you have a large pre-tax traditional IRA, a pre-tax account outside of your current employer’s 401k - you also do not need to worry about a Backdoor Roth IRA.

If you are already maxing out your 401k contribution and do not have any traditional IRA funds (pre-tax accounts) outside of your current 401k, a backdoor Roth IRA is an option for you.

See the Article Here for more info on executing a Backdoor Roth IRA contribution.

See the Backdoor Roth IRA YouTube Video here.

Mistake Number 3: A Bad Backdoor Roth Contribution—Executing a backdoor Roth IRA contribution when you already have a Traditional IRA with significant savings will cost you a far unnecessary tax bill on every dollar you move. Don’t make a Backdoor Roth IRA contribution if you have any pre-tax (traditional IRA) accounts outside of your current employer’s 401(k) pan.

If you are younger than 45, say under 40 or even 30, hit GM status, or are rising quickly and already hitting the top tax brackets.

You have a very long runway for tax-free growth inside of a Roth IRA before you ever go to retire or take withdrawals.

In this situation, if you believe you will continue to make more money in the future and that taxes will be higher in the future than they are today, then you might consider paying the taxes today, putting the money into Roth accounts, and never worrying about taxes on this money ever again.

Still not sure which way to go or have more questions? Shoot me an email at [email protected] 

-Rob

Securities offered through LPL Financial, Member FINRA/ SIPC. Investment advice offered through IHT Wealth Management, a registered investment advisor. IHT Wealth Management and AutomotiveWealth are separate entities from LPL Financial. 

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A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.