Roth IRA Misconceptions and Its Benefits for Your Retirement Planning In 2023!

The Roth IRA can be a powerful tool for your retirement planning in 2023, but there are so many misconceptions you may be wondering whether it’s worth it for YOUR retirement. In this video, Jessica Cannella will go over the common misconceptions of the Roth Ira and how it could be a powerful wealth-building tool for retirement.

The Roth:

Jessica Cannella: The Roth IRA is one of the most powerful wealth building tools that even the average person can use to build a tax-free component to their portfolio, and eventually a tax-free stream of income. Today, I’ll focus on clarifying some of the most common misconceptions that create a barrier to people incorporating this valuable strategy as part of their financial portfolio. I want to inspire you to have the confidence in how a Roth could potentially add value to your portfolio.

Jessica Cannella: I’m Jessica Cannella, co-founder and President of Oak Harvest Financial Group. Today, we’re going to talk about a super sexy strategy known as the Roth IRA. Let’s talk about one of the biggest misconceptions when it comes to the Roth IRA. It’s that age 59.5 rule that says if you withdraw from your traditional IRA, and many people think it also applies to the Roth IRA, that you’re subject to an extra 10% penalty. Now, while that is completely true on the traditional IRA in most instances, it is only partially true when it comes to that Roth IRA.

You’re funding a Roth with after tax dollars and you’ve already paid the tax as a result of them being after tax dollars of course. Anytime you put after tax dollars into your Roth, which is how it gets funded, you are able to access that money no matter what age you are. I said it was partially accurate though, where that 10% early withdrawal penalty does apply in a Roth. Here’s how. Your Roth IRA has the ability to be invested just like your regular IRA or 401K do, invested in things like stocks, bonds, mutual funds, whatever financial tools are in there.

When those tools grow in a Roth, it is true that they grow tax free on the gains and interest and the IRS says, yes, they grow tax free for the rest of your life and you have to wait till you’re 59.5, or you will get the 10% early withdrawal penalty, not tax, but early withdrawal penalty, that 10% if you access any gains in interest inside of that Roth while you’re under the age of 59.5. One other little known aside is that if you’re purchasing your very first home, that 59.5 early withdrawal penalty, that 10% doesn’t apply up to your first $10,000 that you withdraw out of your Roth.

Now, another common thing I hear, “I make too much money, Jessica, to be able to have a Roth IRA.” When clients or friends of mine say that, my first answer is, Well, good for you.” You got to pay to play and that’s the price that you get penalized in the USA for being successful. I joke there, but it really is because this tool is just so powerful, it’s going to grow tax free for the rest of your life. You are right if you think that you make too much money. In fact, those guidelines that you can’t contribute to a Roth. I’ve actually linked in the description box that assesses what modified adjusted gross income is.

Our resident CPA, Joshua Langford, was kind enough to get us some research done, and I posted it in the description box so you could figure out exactly what that means. If you are single and you are filing your taxes single, you can earn up to $138,000, [unintelligible 00:03:18]. Any dollar after that $138,000, you will be ineligible, if you make more than 138K a year as a single filer to contribute to your Roth. The same applies to if you are a married couple and your combined income totals 218,000 modified adjusted gross income or more, you’re also ineligible to contribute to a Roth.

Now, you may have noticed that in both instances I am really stressing contribution, that word contribution, because there is a way around being still able to open a Roth, have an IRA, have the tax free growth, its street name is backdoor Roth. It’s a way to first make your contribution to your traditional IRA and then see if it makes sense for you and your situation to convert it at a later time. You can convert, which is different than a contribution, into your Roth from your IRA. You do pay the taxes in the interim. That’s why it’s an important conversation that you’ll like to have with your financial advisor and ideally your CPA as well, so that everybody is on the same page on your behalf.

It is possible to do what is called a backdoor Roth, and that just simply means that you’re going to make a contribution to your regular IRA and then convert it at a later date into your Roth IRA and pay the taxes in the middle. Don’t worry about Uncle Sam, he still finds a way to get his. Having the ability to have tax-free growth over long term in a Roth IRA could still make a heck of a lot of sense as it relates to your portfolio. Have that conversation with your financial advisor and don’t forget to check out our next video. I’ll mention it again at the end of this one. While I’m on the topic, there is a new tool out, relatively new, called a Roth 401.

If you’re still working, you’re going to want to not miss that video as I run you through the positives and considerations of electing to contribute to your Roth IRA versus your regular 401K and what that could mean tax-wise for you. We talked about making a Roth conversion and how you’re ineligible to make them if you make over $138,000 as a single filer or over $218,000 as a married couple. Let’s talk about what are the parameters? How much can you contribute if you make under those thresholds? In 2023, you can contribute up to $6,500 a year to your Roth with your after-tax dollars, and up to 7,500 with your after-tax dollars if you’re over the age of 50, and that’s known as the catch-up feature.

Catch up? Like catch up, you haven’t been contributing to your Roth, not the kind of ketchup that you put on your hotdog. One important distinction I want to draw as we’re talking about contribution versus Roth conversion is that the limits that we just talked about with the contributions conversely, there is no limit on how much you can convert out of your IRA into your Roth. I like to take this opportunity when I’m having this conversation with my clients to remind them that when we’re looking at strategic tax planning, the limit on the threshold for a conversion, although there’s technically not a limit, in my opinion, in my experience working with my clients, it’s the pain threshold for writing the check for the taxes that you’re going to pay for doing a Roth conversion in that tax year.

When you trigger a Roth conversion in 2023, you’ll get a 1099-R that will communicate to the IRS to tax you on the amount that was converted. Roth conversions and contributions must be made by December 31st in order to count for that year. If you wanted to make a Roth conversion in 2022, it will have had been done by December 31st, 2022. The taxes owed would be calculated on 2022 tax year. You would want to have a plan for paying them in 2023. Your advisor, much like we do, can help formulate a plan on how you’ll pay the tax because you’re going to have some options there.

Now, ideally, you’ll pay with after-tax dollars. Think your savings account or maybe a CD that just matured that you funded with non-qualified funds. The other way to do it is to look at doing a withholding in your IRA, is that you predetermine how much tax would be owed to the IRS for converting IRA dollars or tax-deferred dollars into tax-free dollars into your Roth. That middle is where you’re going to pay the taxes. You can actually determine that you want that– Let’s say you owe $5,000.

If you want to convert, say, $20,000 because that’s what you talked to your advisor about, out of that tax-infested or tax-deferred IRA, then you’ll want to calculate what does this mean in accordance with my tax bracket for what I’m going to owe for getting them to land in the Roth? Those dollars. Because once they land in the Roth, it’s off to the races, they’re going tax free for the rest of your life. [unintelligible 00:08:15] like this, compliance is not going to like that. I just indicated that the market will go straight up. That’s not so, it will go like this depending on what you’re invested in.

If it’s cash, it’ll stay stable and if it’s invested, it’s going to ride the market based on your risk tolerance. Very important for me to draw that distinction since I’m Italian and I do all these crazy hand movements. What does it mean to do a withholding in your IRA? In my example, you want to convert 20,000, get it into the Roth to do this, this, this, or whatever the investment choices you have in there are going to do, but you want to know where are the taxes owed. Let’s just for illustration purposes say that in order to convert 20,000 out of the IRA into that Roth, you’re going to owe $5,000 for taking tax-deferred dollars out of the IRA.

You can have your advisor do a withholding in your IRA, which means the $5,000 that you owe to the IRS goes right to the IRS out of your investment account or your IRA, and $15,000 goes into your Roth. Now if you have after-tax dollars sitting in your savings account or a money market CD, as I mentioned earlier, why not get the full bang for your buck? Convert the whole $20,000 so that all $20,000 lands in the tax-free Roth and pay the piper with $5,000 from your savings. Again, your financial advisor is really going to be the best person to have this circumstantial conversation with you.

If you have your tax-planning meeting with them like we do with our clients early in the year, you then have ample time to save a little bit of after-tax dollars in order to pay Uncle Sam, come following April that you did the conversion for that year. In most cases, when it makes sense to look at Roth conversions like we do for our clients because they’re in retirement and they’re going to run the risk of having too much tax-infested dollars when it comes time at age, it used to be really easy to say age 70.5 or age 72, but check out more of our YouTube videos for the upcoming laws because now there’s different parameters for your requirement [unintelligible 00:10:13] distribution age.

I know that for most people, you’ll be close to 75 if you’re born after 1959. Don’t quote me on that. I just recently got my training on the new rules. We’ll have them posted on our website so that you could check them out. When it does make sense to do a Roth conversion, it’s most important, especially if it’s going to mean you pay potentially less tax now to avoid way more tax in the future. No one knows what the tax code is going to be when we’re in our early 70s or late 70s and we’re having to take out those required distributions from our IRA.

When that makes sense for you, the most important thing is that the Roth conversions are happening strategically over time when it’s appropriate for your situation. Whether you’re paying those taxes off with after-tax dollars from your savings account or doing a withholding, yes, one is more appealing than the other to pay with the after-tax dollars. If it means a difference of not getting them done, hey, think of it this way. In my example, you still got $15,000 over to your Roth. It’s going to be invested and it’s going to grow tax-free hopefully for the rest of your life.

In summary, you might want to investigate if opening a Roth IRA and finding a strategy to get some dollars growing tax-free for you into that account. Roth is generally something worth exploring. The most powerful aspect of a Roth IRA is the fact that any interest or gains are tax-free for the rest of your life, even when you pull the money out to use it. Join me next time, as I alluded to a little bit earlier as we discussed the key differences of the traditional 401K compared to the relatively new Roth 401k. If you’re still working, you’re not going to want to miss this one.