Episode 2: Is Converting to a Roth Right for Me?

Published on: Dec 25, 2019


  • The two types of Roths
  • Contribution limits
  • Traditional vs Roth 401k
  • Roth re-characterizations
[accordion] [accordion-item title="Transcript (Click to see full transcript)"] Ben Christy: So Pete, we know that many people put their money in tax deferred accounts like IRAs, 401ks, similar accounts because they're so stinking and popular and they're so easy. That's how they've been designed because people get those pre-tax dollars. Everybody wants to save a dime today, so that's just the way we're wired, right? We know that these accounts, that money grows inside without having to pay taxes. The taxes come into play when you start withdrawing that. Unfortunately, what we need to talk about today is, is that is really a tax time bomb that a lot of people are sitting on they don't even realize because when it comes to withdrawing your money, that's when you have to pay taxes on every single dollar this pulled out. Ben Christy: Many people, they know that they're going to have to pay taxes on this. They recognize that. We're not preaching to them to open their eyes this morning, but what we're saying is that there's some alternatives and I think a lot of people don't recognize that. They know that they're these are popular accounts. They've been told from birth in many cases, "This is what you do. This is where you match your employers... He's putting money in. This is free money, keep doing this," but there's some alternatives and that's what we're going to talk about today. That's the Roth 401k and the Roth IRA. So what exactly do we mean when we say Roth, Pete? Pete Benson: Well, first off, Roth, R-O-T-H, that's just the name of it. It's a certain kind of IRA and there's two types of Roths. Neither allow, get this, neither of them allow for tax-free contributions. That's the catch, but you pay zero tax when you withdraw the money in retirement. Ben Christy: Okay, Pete. So then let's dig a little deeper and let's start with just one. Let's say Roth IRA. Pete Benson: Mm-hmm (affirmative). Ben Christy: In a nutshell, what is it and what are its advantages really, over your traditional IRA? Pete Benson: Yeah, IRA just stands for the three words, "individual retirement account." A 401k is kind of like a group retirement plan. We're all part of a company. There could be hundreds of people contributing to it. Your IRA is just yours, an individual retirement account. It's an investment account designed for building your retirement savings and there's several kinds of IRAs. When you look at a traditional IRA and a Roth IRA, I kind of like to think of it this way, Ben. One of the things to kind of consider is on an IRA, you play now, but you're going to pay later. Ben Christy: That's a good way- Pete Benson: On a Roth IRA, you pay now, but you get to play later. Ben Christy: Yeah. Pete Benson: Now, we live in a world of immediate gratification now. So don't die of shock when I say that because I know that comes as a huge shock to people out there that we live in that world. But because we do and because we have been told that we're always going to be in a lower tax rate later [crosstalk 00:03:41] we're always told to make sure that you get to play now and then worry about paying later- Ben Christy: That's right. Pete Benson: ... but the thing is, in my business, I get to meet with a lot of people who now, they're very unhappy that they played then and they pay now because now they're in retirement and they're on a fixed income and they just don't have as much flexibility. They can't work overtime and get a little bit more money and everything. So now, is where it's at. Again, just think of it that way. But the thing about the Roth is once you pay the taxes up front, all that money gets to grow tax free forever if you play by the rules correctly. Ben Christy: That sounds good. So let me make sure I've got the basics here. It makes sense to go with a traditional IRA if you believe there's an upfront tax break today. Pete Benson: Yeah, and if you need it and there are people out there who need it. Ben Christy: Right, right. Or if you expect to pay a lower tax rate in retirement, which a lot of people may, but probably don't know that[crosstalk 00:04:45]. You don't know that, but [crosstalk 00:04:47] Right, right, right. Then another thing to keep in mind too is to avoid a withdrawal penalty when taking money out of a traditional IRA. You need to be 59 and a half or do you get that stiff 10% fee put right on top of you. Ben Christy: But let's look at the alternative. So you have the traditional IRA and then you have the Roth IRA on the other side. If you want your money to grow tax free, boy that sounds good, and you want to never owe taxes on the investment gains, in other words, you don't want to pay on the harvest, you'd rather pay on the seed and you can withdraw money tax free, again, this is what it's all about, tax free in retirement, and I think this is the big one for me, Pete, if you think that your taxes will be higher in retirement than they are right now, then you want to look at a Roth IRA. Pete Benson: Yeah. And again, we don't know what the taxes are going to be, but you do need to know what your contribution limits in that are. One of the things that you need to understand is keep up with what you're allowed to put in these. It's pretty simple. You can get on the internet and do a Google search and it'll come up. But basically, the good news is they're the same for an IRA and a Roth IRA. For 2019, if you're under 50 years old, then you can put $6,000 in and if you're over 50 years old, you can put another thousand dollars in. So you can actually put $7,000, but we already know that for 2020, they're raising that by $500 for each. Again, there'll be a larger amount that you can contribute and you need to keep up with that. Ben Christy: Hey friends, if you're ready to take another step toward retirement with confidence and peace of mind, then head over to beaconcm.com and find a few ways you can get started. First, you can always schedule time to come sit down with us and get that second opinion or see how your portfolio stacks up. Or if you're wanting to learn more about developing a solid game plan for retirement that makes sense for you, we'd love for you to join us at one of our dinner events or our lunch and learns. There are several events to choose from at different venues around the city each month. Again, that's beaconcm.com to register for one of these free, no pressure, no products, no obligation, just good solid retirement education and information events. Again, beaconcm.com. Now, back to the podcast. Ben Christy: Well, hey Pete, so Kiplinger calls your IRA, your 401k and those other tax deferred accounts, now get this, I love this quote from them. They say it's a, "sleeping taxpayer that wakes up when we get into our seventies and it growls loudly." Pete Benson: It does. Ben Christy: Now, if you're listening and you're here and you tuned in this podcast and you're in your 30s or forties, even your 50s you're going, "Hey, I've got time. That's not something I really have to worry about today," but again, that flies back on what we said; we're wired for instant gratification, but if you really want to live well, you have to prepare for the future. You have to look at longterm. So let's talk about these popular 401k plans that we kind of... I felt like certainly, for mem my very first job I remember out of college, it was just understood. This is what you do; you go in, you put that money in because you're getting a match. And that's why when I looked up the stat and I was actually a little shocked, I thought it was going to be higher, but as of 2016, the stat shows that over 55 million American workers were active participants in a 401k plan. Ben Christy: Again, make sense because it's what's your kind of told to do. It's kind of the understood. But unlike IRAs, there's several different types. There are only two types of 401k plans that we want to talk about and that's your traditional and your Roth. Let's dive in, Pete. What's the difference between these two types of 401ks? Pete Benson: Well, there's the traditional 401k and a Roth 401k. First off, let me say this, Ben, I would tell folks to ask to see if your company actually allows the Roth 401k. Almost all companies that have a 401k, a traditional 401k and what people have missed out on is that many companies offer both now and a few years ago, they didn't, but now they do. So they assume that because it just wasn't made clear to them that there's the Roth 401k available, they assume that it didn't have it. But most companies or many of them do offer it today. Ben Christy: And that can be as simple as just a check mark from what I've seen on some of these. [crosstalk 00:09:36]. Pete Benson: Yeah, and just ask the HR person or somebody to check that out. You do need to know the difference. The good news is, I know we didn't get into this, but with the Roth IRAs, there are some income limits to how much you can put... If you can put money in your, you and your spouse may make too much money or just you personally, and you can't contribute to a Roth IRA. But anybody can contribute to a Roth 401k. It doesn't matter if you're a high paying executive or owner of a company or anything like this. So the difference is, again, the traditional 401k is more like the IRA. Okay? So you get the tax break now, but you pay the taxes and pay the Piper later when you're in retirement. The Roth 401k, you put it in, you don't get a tax break now, but all that money grows tax free and continues to compound and then you pull it all out in retirement tax free. Then you also need to pay attention to the contributions. Pete Benson: Now, not everyone's able to give up to what they allow you to put in any way, but the limits are pretty high because you can put in $19,000 per year if you're under 50 and then $25,000 a year for those 50 and up. Then there's a catch up provision and so on, so there's quite a bit of money that you can put into it. Again, for those under 50 years old, that adds up to $56,000 into the total employee and employer contribution plan. For those 50 and over, the limit is $62,000 [crosstalk 00:11:17] So that's pretty high. Ben Christy: Well, and I think it comes down to, again, you and I are both big believers in Roths and so don't want to have an unbiased approach here, but I think the big question is do you think you're going to pay more taxes now or more taxes in the future? There's a lot of factors to consider there, Pete. Of course, we can't look into a crystal ball, wish we could because we'd be doing really well if we could look into a crystal ball, we can't. But the way the economy's heading, a $22 trillion debt that the government has piled up, it's going to have to get paid at some point- Pete Benson: Yeah, the Piper's going to come. It's even a good idea to kind of have both because then you have tax diversification just like you have asset class diversification on your funds, and you can kind of decide how and when to take the money out of certain accounts and keep yourself in a certain tax bracket. So there's really good planning that can take place here and folks need to know again, about the difference between the Roth IRA and the Roth 401k. I go back to the income limits again. There are no income limits on being able to contribute to a Roth 401k, but there is just the regular Roth IRA. So you need to know what those things are and keep up with that. It's so easy to find. You can again, just do a search on your computer and there's reliable sites like Fidelity or the IRS or Vanguard and they'll pop right up quick and they'll tell you exactly what those limits are. Ben Christy: Okay, now I loved what you said about it doesn't have to be all or none, right? You can do a balanced approach there. For some people, that is the right approach, not to take all of their 401k and just dump it all into a Roth 401K. But there are some things to consider as you're looking to convert to a Roth. I know before 2018 that you could basically could reverse your Roth conversion decision and pinpoint the smartest amount. Unfortunately, that's not something that you can do now. You're kind of stuck with that. It could be costly if you don't really get that plan just right. Pete Benson: Yeah, it's referred to as a Roth recharacterization And that is one of the big changes with the new Trump plan is retirees face a major hurdle when they do a Roth conversion if they know they're not going to stick with it or don't want to stick with it. It's hard to know exactly what the tax impact is going to be later on. Sometimes they're like, "Oh, let me undo that." You can't do that anymore. You have to stick with it. So make sure you're dealing with a professional and sitting down with tax people to really understand if this is in your best interest. Make sure that it doesn't cost you more than what the gain is. Ben Christy: So as we wrap up this conversation, any final thoughts on what questions people should be asking themselves or even asking their financial advisor as they consider moving some or all of their money into a Roth IRA or a 401k? Pete Benson: Well, a couple things come to mind. One, be a student. Learn all that you can about this. Again, we work really hard for our money. Make sure that we're keeping up with everything. It just makes sense to do so. If this isn't something that you really enjoy and get a lot of big kick out of, find somebody that you trust, somebody that spoken well of, that has a great reputation in the community and let them help guide you step by step, go at your speed, to really know what you need to do. But the other thing I would just say, Ben, is we get down to, "Well, should we do a Roth 401k or just a regular 401k or IRA or Roth IRA?" The best thing you need to keep in mind is keep investing. It's not a bad thing to put it into either one. It's a bad thing not to invest because you just don't understand them or whatever. So you just all of a sudden, you've lost five or 10 years. Keep investing, put money away. Believe me, you're going to need it. Ben Christy: Yeah, good points. So Pete, it's always good hanging with you breaking down these retirement planning to put it into terms that even I can understand. So thanks for taking time to join me today. And to everyone listening, thanks for joining me and Pete for another episode of Beacon Retirement Strategies. You can always hear more at beaconcm.com/podcast. Always remember that peace of mind in retirement requires... Speaker 3: Investment advisory service is offered through Beacon Capital Management, LLC, an SEC registered investment advisor. Beacon Capital Management, LLC is neither an affiliate or subsidiary of TD Ameritrade institutional fidelity investments, Beacon Accounting and Tax Service or Knight legal.   [/accordion-item] [/accordion]

Many people don’t realize they’re sitting on a tax time bomb

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