ROTH; IS IT FOR ME?
When you contribute to a Roth account you will probably pay more taxes today so that in retirement your taxes will be lower. If you already have a retirement account and are considering converting to a Roth, the same will apply to the converted amount. A Roth is beneficial if you expect to be in a higher tax bracket at retirement, as high earnings time is when you face the biggest tax bills. So, will you indeed be in a higher tax break then? No one has that crystal ball since political policies can change, your income may have been affected by a company downsizing, etc. Motley Fool’s article Rule Your Retirement by Robert Brokamp, CFP has a few guidelines:
If you are single and have $37,450 or less in taxable (not gross) income, or are married and have $74,900 or less in taxable income, you are in the 15% tax bracket in 2015. The Roth is probably your better bet.
Since younger workers reach their greatest earning years in their late 40’s or early 50’s it makes sense for them.
The closer you are to retirement will require you to use an online tax calculator to estimate your current and retirement tax liabilities in order to feel comfortable with projections.
Most people drop into a lower tax bracket when they retire.
Since we seem to have large government deficits and underfunded entitlements it is expected tax rates will go up. That would fall to the younger, higher-income individuals or families.
The more income you receive in retirement, the more your Social Security benefit will be taxed. Withdrawals from traditional accounts are included in your income, which can lead to higher Social Security taxation. Withdrawals from Roths are not. So, not only are the withdrawals tax-free, but they might also shield more of your Social Security from taxation. But remember that contributing to a traditional retirement plan or deductible traditional IRA reduces your adjusted gross income (AGI) which affects other aspects of your tax bill. Use an online tax calculator or speak with your accountant to understand your best move.
AGE 70 1/2
You must begin taking required minimum distributions (RMDs) from traditional accounts at age 70 1/2, or wait a year and take two distributions. (Don’t ask, I don’t understand) I have an account that will not only remind me, but with my approval, forward my correct percentage check, so that I never mess that part up. Beyond this age of 70 1/2 you can no longer contribute to a traditional IRA, but you do not have to worry about RMDs with Roth IRAs, and you can continue to contribute as long as you have income. Roth 401(K)s and 403(b)s are subject to RMDs when you no longer work for the company, but all you have to do is transfer those assets to a Roth IRA to make them RMD-free. Woo Hoo! If you have lots of moolah, keeping money in tax-advantaged accounts as long as possible is obviously beneficial in order for you to leave a nice income-tax-free inheritance to your heirs.
There are tables you can access which tell the limits of how much you can contribute to Roth accounts, and higher-income folks may not be able to contribute to a Roth IRA at all. However, anyone of any age can do a Roth conversion. There used to be an income restriction, but that is no longer. Through work the only money you can’t convert is any non-vested employer matches. You will still owe taxes on the amount converted. If you have some sort of financial turn-around after your conversion there is a process called recharacterization you might utilize to change your mind; you have until October 15 of the following year to do that. The conversion cannot be pieced, or less than the conversion, in recharacterization. If you are concerned, more than one account could be utilized.
If you are unable to contribute to a Roth IRA because of income limits, you still might have an option. You can contribute to a non-deductible traditional IRA (at less than 70 1/2, though) as long as he or she has earned income, and immediately convert to a Roth. If you don’t have any pre-tax money in any other traditional IRA accounts, including SEPs, rollovers, SIMPLEs, you can immediately convert that traditional IRA to a Roth IRA, (“you”, meaning you can ignore what your spouse has.) Here is the real bonus: Because you couldn’t deduct the contribution, and because the account had no opportunity to grow, you won’t owe any taxes on the conversion. This is also known as the “Backdoor Roth”.
If you are confused, so are experts, at times. A good bit of caution is warranted, especially when it comes to pre-59 1/2 withdrawals and account rollovers. So triple-check all and work with your CPA for information and confirmation. Do not give up, though. Putting in the time to learn all the details, getting help, and making the moves that are right for you can result in thousands of dollars of after-tax monies.