Do you remember the first time you heard about a Roth IRA Were you in your early 20s ? Was it a parent who told you about it ? Was it a neighbor ? Was it a coworker ?
Everyone hears about a Roth IRA at a different time and it almost seems like you need one , and they can be certainly very helpful and I love talking about them because they certainly can add value . But I'm gonna talk today specifically about how you can get the most out of your Roth IRA .
So we're gonna hop right in but , as you know , wanna go over the reviews that you guys all leave , so thank you for doing so . This comes from F V Grace , who says great show . In the age of the thoughts of the fire movement , I think young people forget to enjoy life and seem to just focus only on saving .
Thank you , f V Grace , who left a five star review , and what I always go back to is my definition of the fire movement . For a lot of you , you guys know fire stands for financial independence , retire early . But that is not my definition . My definition is financial independence , recreational employment , people go Aria .
It's not a big difference from retire early , and I think it is , and the reason for that most people don't wanna retire early and do nothing . Some people do , and to those people , great . They have a very clear vision of what they wanna do . But for most people that come to me , they're between age call it 45 and 60 .
They want to retire early , before the traditional age of 65 . They've saved and invested well and they're going Aria , help me make the most out of this . I want to make sure that I am enjoying my time , and most people don't wanna do nothing . They still wanna work .
Maybe it's part time or in a capacity that's less stressful , but that's what they're looking for . It's that recreational employment less so . I find that people actually just wanna stop working entirely . Now there are , of course , people that reach out to me that do fall in that boat , but for the majority , it's that recreational employment that they're looking for .
So we're gonna connect the dots here to my Roth IRA , so you can see today how I view this for both my clients and my personal wealth . When we look at Roth IRAs , there's five main things I want you to consider so you can get the most out of your Roth IRA .
The first is that you don't get any benefit at all when you put money into a Roth IRA and I can hear some of you going oh yeah , you do . You talk about Roth IRAs all the time , tax-free growth and all of these great benefits , and I go You're right .
And to reiterate what the Roth IRA is for is the following when you put money into a Roth IRA , you get no tax benefit . Today , you make money . You put that money into a Roth IRA . There is no benefit today . It's the growth over 30 , 40 , 50 plus years that makes you go oh my gosh , that tax-free growth .
That's what I'm looking for and that's the benefit of a Roth IRA . Now there's other benefits that I'm gonna go over today , such as no RMDs and what this means for beneficiaries and all these other amazing benefits . But for a lot of people that are just reaching out early on in their career , going , okay , should I do Roth or pre-tax ?
Well , more often than not , roth is gonna make most sense because you're likely to make more money in the future . But this idea that a lot of advisors I find that I speak with are all about marrying Roth forever . If you don't have a really good financial plan , don't marry any strategy . Roth makes sense for a lot of people . Pre-tax makes sense .
For a lot of people it really depends on your plan and where you're at in life what cash flow looks like and all these other variables . So we're gonna start hopping through my list and I'm gonna go over a few things that a lot of people get , I'll say , stuck on , but that maybe not the best phrase for it .
But they'll often think a lot about this and I think it's unnecessary . And here's one of them . It's the five-year rule . Your account has to be opened and funded for five years before you can withdraw the growth or earnings . So this timeline only pertains to the day you did your first contribution . So let's take an example . You guys know I'm the example guy .
If you are 60 today , you start your Roth for the very first time you can access your contribution . So what you personally put in tax-free at any time , but not the growth for the five years . So get a Roth started to start that clock . Now here's where people go wrong is . They'll say I gotta make sure I get that clock started .
I'm gonna be using my Roth IRA first in an early retirement , because I've been saving , investing for all these years and I wanna keep my taxes low . So To some extent they're correct , those that say that Each conversion absolutely has its own what we call separate five-year rule .
There is a lot to track with what I just said , and I realize that , but I want to keep it very simple , and so here's how I want you to think about it .
This five-year rule yes , it does apply , and I'm going to go over it in a little bit more detail but for most people , they want that five-year clock on there , but it's very , very rare that they actually use it ever , and I've only seen it about two or three times in my practice .
Most people are worried about the five-year rule and they never even touch that account until they're late 80s or 90s , because that is the best account to allow to grow tax-free forever .
So it's one of those things that , yes , there's a rule there , but it's also one of those rules I don't want you to stress out over , because more than likely , you're not going to even need to know it Now . There's a lot to track , but the IRS , well , they do their best job to keep it simple , but here's the order it works at .
When you look at a Roth IRA , I mean , if you wanted to take money out of that Roth IRA . How does that get taxed , like what's the actual and how does it work ? And so any dollar you take out comes out in the same exact order , whether it's you , whether it's me , whether it's Bill Gates a contribution comes out first .
So if you put $10,000 and it grows to $100,000 , that first $10,000 , that comes out . That's what you personally put in , that's your contribution . Then conversions come out , then the growth on that money . So the simplest way to think about it is that Roth benefits . They come over time . Don't plan to draw from your Roth right away .
This rule that I just went over also applies to beneficiaries . So the goal here is , yes , start that clock to make sure that five-year rule is essentially being applied to most efficiently , but don't worry about it in most cases , because you're not going to want to touch these assets .
If you have a touch the assets for a long time I should say your brokerage account , maybe your IRAs , your 401Ks more often than not those are the accounts you're going to want to pull from before tapping into your Roth IRAs . So that's the first thing that I want you to think about .
The second thing with Roth IRAs is a lot of people will say , oh my gosh , I make too much to my Roth IRA . I make too much to contribute and because of that I don't know what to do . And so there's something known as a backdoor Roth and there's all these different words out there , and they do it to confuse you .
I'm just kidding , that's not why they do it , but they can make it confusing because you heard me a few minutes ago . You say conversions . I'm now going to say conversions again , but it has a different meaning . So I'm going to very clearly explain the difference there .
When people talk about a Roth conversion , what they're saying is what if you move money from your IRA or your 401K into your Roth IRA to pay less taxes in the future , with the idea being , what if we converted dollars today , where you're in a lower tax bracket versus where you'll be in the future at a higher tax bracket , and investing that difference and
getting tax-free growth ? That's the benefit of a Roth conversion . There's also something known as a backdoor Roth conversion . Some people call it a backdoor Roth contribution , but this comes about when you make too much money . So , depending on how much income you're making , the government will say , hey , you make too much money , you can't do a Roth IRA .
But you listen to the early retirement podcast and you know there's a way around it , and there is , and that depends on your income . But if you are unable to contribute to a Roth IRA because you make too much money which I'm going to tell you right now what that is you can still get around this rule .
So if you're single and you make over $153,000 , that's your modified adjusted gross income you are technically not eligible to do a Roth IRA contribution . If you're married , filing jointly , and you make over 228,000 , same applies to you . Now there's something known as the aggregation rule , and this really quickly becomes complicated .
But if you have other pre-tax balances , it makes it a whole lot more difficult . There's a form you have to fill out If you want to move money by putting money into an IRA , telling the government you don't want to deduct it and then moving it to a Roth IRA . But for most people they actually don't need to do this backdoor Roth IRA that I just explained .
So sometimes I like to explain the tactic and then say hey guys , maybe you don't even need to do it . Here's a real life example . Someone came to me and they said Ari , I'm saving a very healthy amount . I want to do everything possible to set myself up well for the future . I said wonderful , what are you doing today ?
They said , ari , I'm maxing out my 401K . In fact , it's not my 401K , ari , it's my Roth 401K , so I'm putting everything in there possible . I am over age 50 , so I'm doing the catch up to that . So I've got $30,000 going to my Roth 401K . My employer's putting in some money there . I'm doing my HSA .
I said awesome , what else do you feel that you're not able to do today ? They go I feel like I'm able to do everything I want to do . I just want to add and save more money . I said okay , but you and me , if you could do one thing , what would you do ?
They said Ari , there is one trip I've been putting off for many years , but there's only so many more years I'm going to be working . In this case it was about five . So they just said I want to absolutely do everything possible . We went through a planning projection and they saw they were in a very comfortable position to retire in five years .
And so then they went Ari , what about that backdoor Roth ? Isn't that something we forgot to do ? I said no , it wasn't something we forgot to do . But you wanted to kind of get in this mindset of can I max out everything for the sake of maxing out everything , which is a really weird way of thinking about it .
But there's this idea that if we don't max out everything or take advantage of every special rule , that we're not on track to retire and if financially it makes sense to do these things well , then on paper we go , wow , we should do that . But sometimes it actually makes sense from a life perspective to go , oh my gosh , I've saved and invested plenty .
I have more than I know what to do with . I'm going to always save and invest more , but to what point is that a detriment to lifestyle today ? To what point do you know where your health is going to be in 10 , 15 years from now ? We don't .
And because of that , this was someone who went , oh my gosh , for the first time in my life , I'm not going to max out or take advantage of these rules when I can , and it was a really weird mindset shift .
But just because I'm talking about all of these different avenues to put another , in this case $7,500 into a backdoor Roth for this person to reach out to me doesn't mean that you need to do so . It's one of those things that people often go oh my gosh , that's the maximum . If I don't do that , I'm not going to be on track for XYZ .
That is not what that means , so just want to clarify that . Now , another reason Roth IRAs can be so valuable they're not subject to required minimum distributions . So , unlike other types of investment accounts , you are not required to take these distributions at a certain age A lot of you are listening to this in your 40s or 50s or early 60s . Go to RE .
I don't even know what you just said . Rmds I've heard of them . My grandpa talks about them . I think he worries about them , but I'm not worrying about them . I'll worry about that in 30 plus years . If you were to do that , you're going to be looking at a big tax bill in the future more often than not if you've saved and invested well .
So if you're able to just have the mindset of , oh my gosh , what if I do some of these things today , pay a little bit of taxes to avoid paying a ton in the future , you might really see you could be in a wonderful position . But these RMDs , they don't begin for most of you until age 75 , but it says early as age 73 .
But here's what you need to know about it . If you save and invest to your Roth IRA , taking advantage of this tax-free growth , this is amazing , these RMDs you don't have to worry about yourself , but you do have to worry about them when you pass away , meaning there are required minimum distributions for beneficiaries .
It's just not something you personally have to worry about . Another aspect to Roth IRAs why I like them they're not included in provisional income , and you're going to argue what on earth is provisional income ?
Provisional income is essentially how your social security gets taxed in the future , something else you don't have to worry about quite yet for a lot of you , but it's fun to think about at least fun for me to make sure you pay less taxes in the future , and this is the work I do for my clients . So how do you think about what provisional income is ?
Well , it's your gross income plus any tax-free income , so things like municipal bonds plus 50% of your social security benefit . It helps understand , okay , when I'm looking at my whole tax picture , what am I looking at ? What percent of my social security is going to get taxed ?
How do I make sure I'm looking at this really intentionally and not paying any more taxes than I need to . Another reason I love Roth IRAs they help keep Medicare premiums low , so Roths are not included .
When you pull income in Irma calculations , you don't have to worry about any extra Medicare surcharges and it can help lower your Medicare Part B and Part D premiums . And then , lastly , here just to summarize spousal Roth IRAs are available .
A lot of people will forget about this , but if one spouse has retired and one spouse is still working , if that one spouse makes 15,000 a year , you're able to do two Roth IRA contributions . You can do a $7,500 assuming you're over age 50 for yourself and $7,500 for your spouse , regardless of their working status .
Now , you do need earned income to be able to contribute to a Roth IRA , and all of these are often overlooked Not all of them , but most of them . When it comes to okay , you know Roth IRAs , that five-year rule , how do I make sure I think about that ?
Well , yes , think about it , get the clock started , but more often than not , you're not going to want to pull from your Roth IRA Back to a Roth conversion . Can you contribute the maximum and try to do all these fancy techniques to get the most in , you can , but whether it's needed for your plan , I'm not so sure .
What if that went to a brokerage account and you could use that to help bridge the gap to retire early ? Okay , that's one scenario . What if you were to say already truly , there's nothing else I wish I could do this year ? I'm doing everything I want to do . I'm going to actually do that back to a Roth . Okay , but do we have another IRA ?
Because that's going to impact the actual implementation of that . Back to a Roth conversion RMDs if you're projected to have large RMDs , can you do Roth conversions and allow the Roth IRA to be a really powerful tool ? Provisional income don't worry about that if you're in your early 40s , early 50s , listening to this .
But if you're in your early I'd say early 50s , you can understand how this plays a role . But I really want to be intentional , but not overwhelming any of you to the point where you're like oh my gosh , I'm tuning out here .
The goal here is to make sure this is really settling to the point where you're like I am crystal clear on that subject and then helping keep Medicare premiums low . You're going to be grateful for this later .
But when you eventually are charged for Medicare , you want to make sure your monthly income is not more than most , and for a lot of people they forget about this . They don't do any conversions or they convert incorrectly or all these things . And then they look at their monthly statement like , why am I paying so much more every single month ?
And this is why , lastly , that spousal Roth IRA technique A few other pro tips is that for people that do have a Roth IRA , more often than not you want that 100% growing , 100% equities , taking advantage of the tax-free growth . I did an episode last week on asset location .
Roth IRAs are one of those accounts you want to absolutely make sure is predominantly in equities 100% , if you're comfortable with it to take advantage of that tax-free growth forever . It doesn't mean you need to be invested all of your other accounts the same way , but that Roth account , more often than not , is the account you're going to touch last .
And then for some people they go Aria , is this the last year ? You know I've got five more years till I retire . Does that mean I only have five more years of contributing to my Roth IRA ? I go yes , now you could do some part-time income and still make enough to contribute . So assume you make $3,000 in a year .
You can only put $3,000 in your Roth IRA . However , you are able to convert in unlimited amounts . So if you retire early call it age 55 , you want to convert those dollars to your Roth IRA . There's not a limit . There's no $6,500 limit If you're under 50 or , you know , 7,500 over 50 , there's no limit at all .
You can convert and pay taxes on whatever you'd like and it completely depends on your , of course , tax picture . So hope this quick 15 , 16 minutes on Roth IRAs was helpful , made you think a little bit differently about some of these topics .
And , of course , if you're looking for more detail of a customized strategy and plan , that's of course what I love to do . So reach out to myself . You can see in the description below you can click a link to apply to work with me and I look forward to speak with you guys soon . See you next week .
Thank you for listening to another episode of the Early Retirement Show . If you have a question that you want answered in a future episode , you can always go to my website , earlyretirementpodcastcom . That's earlyretirementpodcastcom , and you can go ahead and submit a question that I'll look to answer in a future episode . Thank you all for listening .
Please do rate it , review it and share it with someone who you think would benefit from this information . If there's anyone out there that you know , I certainly appreciate it and I will see you all each week . Hey guys , it's me again . Please be smart about this . Nothing in this podcast should be construed as financial , tax or legal advice .
Consult with your tax preparer or financial advisor before taking any action . This podcast is for informational purposes only .