Episode 4: 3 Tips and a Mistake: Roth IRA's

in this episode, Hunter talks about 3 tips to maximize a Roth IRA and one mistake to avoid. if you like what you hear please share and leave a 5-star review. 

This podcast is for educational purposes only. This is not financial advice. This communication should not be relied upon as the sole factor in an investment making decision or financial planning decision. If you would like help, please seek a financial tax or legal professional. 



Website: palmvalleywm.com
Email Hunter@palmvalleywm.com

Check out the Palm Valley Wealth Management Website
PalmValleywm.com

Check us out on
Instagram
LinkedIn
Facebook
Listen to the Podcast Here!
Apple
Spotify

Transcript

0:08

And welcome to the retire early retire now podcast. This is episode number four. I am your host hunter Kelly owner of Palm valley wealth management. And this episode, I am starting a new series called three tips that a mistake. And in this episode, we will cover the Roth IRA. This is a play on two truths and a lie. Thought it would be a good way to cover a topic fairly quickly, give you a couple of tips on how to maximize a, in this case, a Roth IRA, but then also a mistake to avoid that. I see commonly through clients and prospective clients. But before we dive in, just want to remind you guys that this podcast is for educational purposes only. This is not financial advice. This communication should not be relied upon. As the sole factor in an investment making decision or financial planning decision. If you would like help, please seek a financial tax or legal professional. And as always keep a Palm valley and mine when making those considerations. And we are in episode number four. So if you were one of the few that have listened to all four episodes up to this point, Just want to say, thank you. and we're on apple podcasts now. So if you could share this episode or any other episode that you find valuable and leave a five star review, that'll help, retire early retire now out tremendously. Before we hop into our three tips. Just want me to cover the basics of what a Roth IRA is. And the Roth IRA was created in 1997 by Congress. And in 2006, they allowed. the ROV, the contributions to go into employer plans as well. but many carriers. didn't really make it common until about probably 10 years ago is when I, at least when I recognized it. How a Roth IRA works is you can tribute. After tax dollars, whether that's from your bank account, into the Roth IRA or through payroll deductions into your 401k. And then that money will grow tax deferred. And then the distributions later on down the road. We'll be tax-free as it currently stands in 2023, an individual can contribute up to$6,500 a year in to the IRA. With a thousand dollar catch-up provision. If you're over the age of 50. And then, for the 401ks, you can contribute up to 22,500 with also a$6,000 catch up provision. For the Roth IRA. There are income limits. these elements do not apply to the employer plans, but it does apply to the IRA plan. In 2023, if you're filing single, it is a$153,000 income limit. And if you're filing jointly, it is a$228,000 income limit. Now there are some phase out. So if you're just below. The 2 28 or 1, 2, 3, you can contribute a little bit, but it does start to phase out. And then once you hit those 1 53 and 2 28. you will no longer be able to contribute. But as we will talk about later. you do still have an option to put into the Roth IRA. Roth IRA is very similar to a traditional IRA. And the fact that you have to wait until 59 and a half to take distributions. but there is a less commonly known five-year rule. So, once you open and make that first contribution, you do have to wait five years or 59 and a half. Whatever comes with later. To be able to access the. Growth that you receive in that account. without any penalties or taxes. now again, the five-year rule is not as common where I see it every now and then is when maybe someone retires a little bit earlier than expected. And they do what's called Roth conversions where they're taking money from their IRA. They're paying taxes on it and putting it into their Roth IRA. and then something changes and maybe they need that money. If there, if it hasn't been five years yet, Then, they would not be able to access that growth without taxes or penalties. And we will, talk about what our conversion is here in just a little bit. But just to review what a Roth IRA is. Are you going to put money into this account? Post-tax and then it will grow tax deferred and be tax-free later on down the road. And then you do have the option potentially to use. Use a Roth money inside of your employer plan as well. So tip number one. Most people don't think. Of it this way, but. There's actually no immediate benefit to putting money into a Roth IRA. The benefit comes into that defer growth. So in an ideal world, you would have maximum amount of growth possible. And this account to receive the most benefit because the more it grows, the less, youth. Theoretically would pay in taxes versus having it in a different vehicle. Like a traditional IRA. Or even just a normal brokerage account. That's taxable. So the question is how do we maximize that? Well, we maximize that by making sure that the assets that we have in there, the investments that we have in our Roth, funds, whether that be in the 401k. Or in our IRA. Our growth. Mind it. Right. And so we want to make sure that this falls within our risk tolerance, we don't want to be too risky for what our situation calls for. But if there's a growth component in your portfolio, having it in the Roth IRA would. Help you receive the most benefit of that Roth IRA. Because again, you're getting that tax deferred growth and then eventually those distributions would be tax-free as well. And so, in practice I've seen multiple times that perspective clients come in. They, bring in their statements from their Roth IRA or their 401k. And, and then in their investment lineup, They're in government bonds, corporate bonds, things that are not very growth oriented. And so they're not really maximizing the capability of what the Roth gives you from a tax perspective. So again, what we want to do is we want to think growth in the Roth IRA. Tip number two, maximizing an early retirement with a Roth IRA. So, how do we do this? Um, so we can maximize. Our early retirement by utilizing. Roth conversions. So again, what is a Roth conversion? A Roth conversion is when you have traditional or pre-tax money in your IRA. Maybe a 401k that you're going to roll over into an IRA. And you move that money into the Roth. IRA. You pay taxes now. And you move that money into a Roth IRA. So an example that I want to give you that could potentially save you thousands of dollars in taxes, let's say you're in your final few years of work. And you're making enough to be in a 24% tax bracket or your effective tax rate is north of 24%. Well, then you retire and then your income potentially as much lower. And so maybe your effective tax rate is 10 or 12 or 15%. So you can decide. Okay, well maybe if we have all of this money, In our traditional IRA. Would it make sense for us to go ahead and convert at a much lower rate? When we know we have years, maybe 10, 15 years of a lower income before social security starts. Before required minimum distribution starts. And so what we can do is we can convert. instead of at a 24% bracket, maybe we convert at a 10 or 12% bracket. And we would convert a little bit at a time for that 10, 15 year period. So let's say we have a traditional IRA of a million dollars. Maybe we convert 25,000 or$50,000 a year, depending on where those brackets are and what makes most sense. we convert that money over a 10-year period. So maybe we're able to convert.$250,000 over that 10-year period or$500,000 over that period. What that isn't going to allow us to do is one we're paying a lower tax bracket than when we were working. But two, when we hit that required minimum distribution age. So basically when the government says, Hey, You have money in pre-tax accounts? We want our revenue. So we're going to require you to take a distribution. Well, because we've converted 250 500,000 of that. That money. That account balance and our pre-tax accounts is much lower. So the. The required distribution will be lower. And so, now we're not having to take, potentially. A hundred thousand dollars out of our IRA and have a higher tax bracket than, if we did those conversions and maybe our requirement distribution is.$25,000 or$50,000. so. I've been able to do this with clients and they have early retirement. We run. our projections on how much we want to convert each year. And then that ends up helping them save tens of thousands of dollars a year. in retirement and then making those requirement distributions much lower than if the money had set in their traditional ira and groove or that 10, 15 year time period So ultimately you're just giving yourself flexibility with your tax brackets. When you retire early and consider, these Roth conversions. Tip number three, spousal contributions. So this will be a short and sweet one. But, two situations where you can maximize a Roth IRA here is if you have a spouse that is a stay at home spouse, and then you have a bread winner, or maybe you have a spouse that retires early. And then the other one continues to work. As long as one spouse is making. At least$15,000 a year or enough to cover the maximum contribution. Both spouses can contribute to their Roth IRA. So. whether you're just trying to maximize that deferred growth later on in life, or if you have a certain savings rate that you're trying to get to, utilizing the spousal contribution. can be a big help in obtaining both your savings goal. But also. Getting that money into the Roth IRA for that deferred growth. And so that'll wrap up our three tips. So let's hop into our mistakes. So one mistake that I see quite often is, when people try to do what's called the backdoor Roth. they don't realize that there is something called the pro-rata rule. So let's back up real quick. What does a backdoor Roth? This is when you're making too much money. And the IRS says, Hey, you cannot contribute to a Roth IRA. As i stated earlier that income limit is 228,000 for married filing jointly and 153,000 for filing single But there is still a way to make a Roth contribution. Even if you are above those income limits and that is through what we call the backdoor Roth. And it's essentially what you do is you. Place a non-deductible contribution into your IRA. You convert that contribution to your Roth IRA. And wallah you have created. a Roth contribution in a sense. And so, one of the things that you need to consider when doing this is if you have any sort of traditional IRA money. If you put a nondeductible contribution and then, convert, you will, have to do what's called the prorata rule. So. Basically a proportion of that traditional money will convert and you will essentially pay taxes. And so couple things, one you'll end up paying more taxes than you thought in that given year. But then moving forward, you will have basis. You will have a non-deductible amount of money. Some money that you've already paid taxes on in your IRA. And so that makes it a bit complicated for tax reasons Because there will be a bit more reporting. On your tax return. And then, when you start taking distributions out of your IRA, then you gotta worry about. The growth coming out first and the pre-tax money coming out first before you get to your basis, which would be that portion that you've already paid taxes on. So it turns into kind of a big pain. so the best way to do this is to make sure that there is no IRA money. And you, open your IRA. You only put that nondeductible contribution and then you do the conversion right away. And then one other thing that people commonly misunderstand is it's not about the account as the aggregate of the money through all the IRA accounts. So if you have a IRA at fidelity, And the IRA Schwab. they would count as one IRA and the IRS as eyes. So just because there's no money in that fidelity IRA. That doesn't mean that you can avoid the pro-rata rule. And then we'll wrap up this episode. I hope you guys enjoyed this. three tips and mistake. If I get a good response, I will continue doing these. please again, share and leave a five star review. If you have any specific questions about what was talked about today, you can reach me at hunter at Palm valley, wm.com. Or you can visit our website at Palm valley. uwm.com. And we'll see you in the next one