Roth Iras are powerful and flexible financial planning tools. They are also complex; Many people are not familiar with all aspects of the Roth IRAS, here are nine facts about the Roth IRAS that may surprise you and influence your retirement decisions.
Roth IRA contributions can be used as emergency funds
Roth contributions are non-deductible. The advantage of this is that you can withdraw your contributions at any time for any reason and no taxes or penalties apply. With this liquidity, the Roth IRA can be your emergency fund.
However, before planning to use Roth for these purposes, please be aware that the definition of “contributions” does not include amounts converted to Roth and does not include investment income.
For example, if you deposit $5,500 and the amount grows to $6,000, you can withdraw $5,500 in contributions without taxes or penalties, but taxes and penalties may apply if you withdraw $500 in profits.
Some may use a non-deductible IRA to fund Roth
If you make too much money, you can't contribute to the Roth IRA - or can you? Some people who have all their other retirement money in qualified retirement accounts can make a non-deductible IRA contribution each year and then convert it to Roth, thereby adding to their Roth IRA each year. This is sometimes called "backdoor Roth".
The key to making this work without paying additional taxes is to make sure you don't have other IRA accounts. In some cases, you can even transfer a self-directed IRA back to a company plan so that you can use Roth's backdoor strategy in later years without having to pay taxes on the converted amount.
You can transfer your 401(k) after-tax contributions to a Roth IRA
Many employer plans allow you to make after-tax contributions. Upon retirement, these post-tax contributions can be transferred directly to a Roth IRA. Any investment income from after-tax contributions cannot be carried over to Roth, but amounts you have contributed can.
If your employer's plan offers this option, you can accumulate after-tax savings and then use them to fund a future Roth IRA. This is beneficial in retirement because withdrawals from a Roth IRA are tax-free and do not affect other items on your tax return as withdrawals from a traditional IRA do.
Roth IRAs do not have mandatory minimum distributions (RMDs)
One of the great things about Roth IRAs is that, unlike traditional IRAs, there is no age when you should start withdrawing money. This means there is no pending tax bomb waiting for you at Roth.
However, heirs who are not your spouse will be required to receive mandatory payments from Roth, but these payments will not be taxed.
You can contribute to SIMPLE IRA and Roth IRA
If your adjusted gross income is below the Roth IRA contribution limit, you can contribute to the Roth IRA as well as the SIMPLE IRA to maximize your retirement savings. SIMPLE contributions will be deductible, but Roth contributions will not.
This dual funding strategy gives you the opportunity to reduce your taxable income now and save some of the funds in Roth for tax-free retirement benefits. This can be beneficial for those who work for themselves and try to save as much as possible for the future.
Your employer's plan may allow Roth contributions
Many 401(k) plans offer the option to make Roth contributions. This is called a Roth Assigned Account. Check with your employer to see if their plan gives you a choice of contribution types.
In some plans, this must be all Roth or all tax-deductible contributions; other plans allow you to do some of them. If your employer's plan does not currently allow Roth contributions, ask them to add this option the next time they make changes to their plan.
Age is not the most important factor in determining whether you should finance Roth
Conventional wisdom says that the younger you are, the more time you have to tax-free grow money in Roth. It's true, more time makes Roth better, but age is not the primary factor to use when deciding whether to top up an IRA or a Roth IRA. The main factor is your tax bracket – both your marginal tax rate now and your expected marginal rate at retirement.
If your expected retirement tax rate is lower than your current tax rate, deductible contributions may be better. If your retirement tax rate will be the same or higher - which is often the case for those with large 401(k) or IRA accounts - then Roth accounts may make a lot of sense to you.
You can make a matrimonial Roth contribution
Even if your spouse has no income, if you have income, you can make an IRA contribution on their behalf. This is called a spouse contribution to an IRA. Many couples can double their savings in a tax-adjusted retirement account by taking advantage of this benefit.
Ask your accountant or financial advisor if your financials are such that you qualify for a Roth Spousal Contribution.
Roth conversion calculators miss some points
You can convert traditional IRA or 401(k) money to Roth. Many online calculators calculate the results of such an operation to help you understand if it makes sense for you. However, these online Roth conversion calculators miss a lot.
For example, they don't take into account the impact of future mandatory IRA withdrawals and how that affects your Social Security taxation. Roth can help reduce this impact. All things considered, in many cases the Roth conversion can be more profitable than what online calculators suggest.
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