How to Retire on Time

"Hey Mike, can you clarify what happens when funds go into a Roth IRA?"

Discover the rules behind Roth IRAs, contributions to Roth IRAs and IRA to Roth conversions, so you can be more deliberate in your tax planning.

Text your questions to 913-363-1234. 

Request Your Wealth Analysis by going to www.retireontime.com 

What is How to Retire on Time?

Welcome to How to Retire on Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice you've heard hundreds of times. This show is about getting into the nitty-gritty so you can make better decisions as you prepare for retirement. Text your questions to 913-363-1234 and we'll feature them on the show. Don't forget to grab a copy of the book, How to Retire on Time, or check out our resources by going to www.retireontime.com.

David:

Hey, Mike. Can you clarify what happens when funds go into a Roth IRA?

Mike:

Yeah. There's a lot of misunderstanding with Roths and timelines and restrictions. Yes. So the first important thing to understand is, first, you're limited on how much can go in there.

David:

K.

Mike:

K? Kind of.

David:

Okay. Do tell. Explain.

Mike:

Yeah. So a Roth is a retirement account. Right? So it means you're not paying capital gains if you trade into it, and then at the end, you can sell everything, and then you can take it as income, you're not paying any taxes.

David:

Okay.

Mike:

K. What's the sibling of a Roth? It's just a traditional IRA.

David:

Alright.

Mike:

An IRA, same thing, you grow without paying capital gains tax. When you take funds out, you're you're going to have to pay income tax. Mhmm. Okay. So there's two mechanisms you gotta understand.

Mike:

One is a contribution, and the other is a conversion.

David:

Okay.

Mike:

K? Here's why. If you're earning w two income, you know, a 10 to nine income, if you've worked, there's a wage and it's on your tax return. As long as you qualify, because if you earn too much money, you can't do this, but you can contribute to a Roth IRA.

David:

Okay.

Mike:

That's got a five year restriction.

David:

Yeah. What's it restricted from in five years? What does that mean?

Mike:

It just means you're not supposed to spend it for five years.

David:

It has to stay in there. It goes in. It's gotta stay in for five years.

Mike:

Yep. If you're contributing. Yep. Okay. That's a contribution.

Mike:

Now a conversion means you have IRA assets, and then you converted it to a Roth. Now to make it simple, let's just assume you've got a four zero one k and you're doing some conversions, and you're you wanna also spend income on it. If you if you convert an IRA dollar amount to a Roth, the dollar amount that moved over, you can take that out whenever.

David:

Okay.

Mike:

There's no restriction. You just paid the taxes on it. They're not concerned about that. But the gains of the money that just moved over, that has a five year restriction. So you've gotta make sure you're doing good accounting.

Mike:

Do you see the difference, though?

David:

Yes.

Mike:

New money grows, five year restriction. Mhmm. But dollar for let's you put in $50,000 to an IRA. Okay, you can take 50,000 of those dollars, assuming it's a new account

David:

Yeah.

Mike:

Whenever you want, but the growth that came from the 50,000, that has to stay in there, so some of it starts to stay.

David:

Okay. Okay. Now, should we also say that if you wanna take money out of a Roth, you have to be 59 or older?

Mike:

Mhmm.

David:

Yeah. So there's there'd be a penalty if you took it out.

Mike:

10% penalty. Yeah. 10%. There are some exceptions.

David:

Mhmm. Right.

Mike:

But it's better just to just don't touch it. Yeah. It's it's a retirement account because it's intended to lack liquidity or have a penalty so that you save it for retirement. Mhmm. You see how illiquidity is actually your friend?

Mike:

Yeah. People would probably not do as good of a job saving for retirement if their IRA accounts, their Roth accounts were just liquid. They could use it whenever they wanted to.

David:

Right. It'd be too easy to put your hand on that cookie jar. Right? Mhmm.

Mike:

So Now this opens up more of a conversation though. Yeah. So to get funds into a Roth, some people don't qualify for the Roth, so you might do a backdoor IRA to Roth conversion. That's where you put money after tax funds, just, you know, your your savings account into an IRA. You may be able to do that, and then you convert it.

Mike:

Oh. Maybe there's a small tax savings. It's usually not huge, but it's nice. Or you could do a mega backdoor Roth conversion. There there's all sorts of different variations on getting money into an IRA or an IRA like account and then get into the Roth.

David:

Okay.

Mike:

But at the end of the day, it really breaks down to one simple thing. How do you get to the Roth and what's really restricted? Just know there's a difference between contribution and conversion. Mhmm. That's that's the simple definition.

Mike:

You can do conversions before 59 if you pay the taxes out of your own pocket. Mhmm. If you're after the age of 59, so you're wiser than 59, then you're able to move dollar for dollar over, and then just withhold. Like, let's say there's a $50,000 conversion, and you withheld 10,000 of it to pay the taxes. K.

Mike:

That's 20%. That means 40,000 would be in the Roth at the end of that conversion, and 10,000 was withheld for your taxes at the end of the year.

David:

Okay.

Mike:

When you're 59 and half, it's easier to do either the Roth conversions. If you're younger and you can afford it, it's better, you but don't wanna stretch yourself too thin.

David:

Okay.

Mike:

Just things to think about.

David:

Yes.