Everyone seems to have a general concept that Roth IRAs are a pretty special type of account. In this video, Shane Tenny, CFP®, explains what they are, how they work, and whether high-income families can use them.
Transcript:
[00:00:03.660 --> 00:00:12.899] Hi, everyone; Shane Tenny here, managing partner at Spaugh Dameron Tenny coming to you today to talk about Roth IRAs, and what makes them so great.
[00:00:12.950 --> 00:00:23.510] Everyone seems to have a general concept that Roth IRAs are a pretty special type of account. But why exactly, and can high-income families even use them?
[00:00:23.540 --> 00:00:25.359] Well, that's what I want to explain today.
[00:00:25.460 --> 00:00:51.899] Now, to start understanding Roth IRAs, it's helpful to draw a baseline by giving you a little bit of foundational information around traditional or regular IRAs. You see, both an IRA and a Roth IRA have the same contribution limits each year. Right now, it's about $7,000 for 2024, and 2025. If you're under 50, and if you're over 50, you can put an extra 1,000 bucks in. So, the total limit is 8,000.
[00:00:52.420 --> 00:01:01.780] And actually, that's about where the similarity ends. You see, with a traditional IRA, the money that you contribute might be tax deductible to you.
[00:01:01.830 --> 00:01:13.430] It'll grow without any taxation, so it's deferred. But when you take money out of a traditional IRA in retirement, say at 60, or 65, or 70.
[00:01:13.570 --> 00:01:22.660] All the money you withdraw is taxed at income tax rates, the income tax rates that are applicable at that time based on your income and tax laws.
[00:01:23.040 --> 00:01:35.050] In a Roth IRA, by contrast, the money that you contribute each year is not eligible for any sort of deduction. And so, it's considered after-tax contributions.
[00:01:35.320 --> 00:01:48.500] But it grows tax deferred. And when you take the money out in retirement, it's all tax-free - the original deposit and all the growth income tax-free. It's a beautiful thing.
[00:01:49.290 --> 00:02:04.029] Now, that is why Roth IRAs are so powerful because individuals who have a long time for their money to grow have the chance of building significant free savings for their retirement.
[00:02:04.800 --> 00:02:13.670] So, with that said. Can high-income families even use Roth IRAs? Isn't there some rule that says if you earn too much, you can't use them.
[00:02:13.830 --> 00:02:28.630] And the answer is, yes, the IRS does restrict individuals with incomes over about $150,000 and married couples with incomes over about 250,000 from making contributions to Roth IRAs.
[00:02:28.810 --> 00:02:34.780] But there is no income restriction on making a contribution to a traditional IRA.
[00:02:34.820 --> 00:02:40.519] And this opens up a strategy you may have heard of called the backdoor Roth conversion.
[00:02:40.550 --> 00:02:47.199] I want you to pay attention to how I explain this because there's a big difference to the IRS between contributing and converting.
[00:02:47.880 --> 00:02:50.659] The Backdoor Roth Conversion works this way.
[00:02:51.060 --> 00:02:57.940] You open up an IRA, for which there's no income limit, and contribute, say, $7,000 (current limit for those under 50).
[00:02:58.360 --> 00:03:05.419] After the money is in there and based on the fact. You have a 401(k) and your income. It's probably not even deductible.
[00:03:05.660 --> 00:03:12.969] Once the money's in there, you fill out a single form and convert that balance over to a Roth IRA.
[00:03:13.180 --> 00:03:19.250] From there on, any growth occurs income tax-free when you follow the rules.
[00:03:19.760 --> 00:03:29.589] And so that, my friends, is how high-income families can get a Roth conversion and build tax-free income for their retirement.
[00:03:30.100 --> 00:03:42.469] You'll definitely want to check out our blog article on the tax forms that are required to substantiate a backdoor Roth conversion. It's kind of technical and a very helpful resource that we've put on our website.
[00:03:43.140 --> 00:03:55.130] As always, don't forget to talk with your CPA or your tax advisor about this, so you can understand exactly how it relates to your own situation. And if you have questions, please reach out to us. We're always here to help.
[00:03:55.180 --> 00:04:01.010] For now, you're older and wiser when it comes to Roth. IRAs, traditional IRAs, and backdoor conversions.
[00:04:01.180 --> 00:04:02.620] See you back here next time.
Shane Tenny is the managing partner of Spaugh Dameron Tenny. Along with hosting the Prosperous Doc® podcast, Shane has a true passion for behavioral finance, helping clients and audiences understand how to develop successful strategies based on their unique temperaments. An accomplished and highly engaging speaker, Shane is regularly interviewed for television and podcasts, is actively involved in the Financial Planning Association®, and contributes to industry advisory boards.