The Need-to-Know Details About Roth IRAs and 401ks, Ep #62

How do I feel about Roth IRAs and 401ks/403Bs? What about the Backdoor Roth IRA? They can be an important tool in your retirement planning. But how do they work? What is the best way to optimize them? Learn more in this episode of Retirement Made Easy!

You will want to hear this episode if you are interested in…

• [2:27] Learn more about Roth IRAs/401ks/403Bs
• [7:51] Conversations about capping the Roth IRA
• [13:09] The basics of the Backdoor Roth IRA
• [17:24] Why I’m passionate about Roth IRAs

Learn more about Roth IRAs/401ks/403Bs

I strongly encourage people to use a Roth IRA whenever they can. A Roth IRA allows you to contribute money after taxes. This allows that money to grow tax-free, which means when you take a withdrawal taxes will not be removed.

Some people also have access to a Roth 401k or 403B through an employer. Not all 401ks/403Bs have this feature—I wish they would. It’s certainly not the standard (but it should be). The benefit of a Roth 401k is that there is no income limit compared to a Roth IRA.

I recommend with a Roth 401k or 403B, roll it into a Roth IRA by the age of 72. Why? They have a required minimum distribution. The Federal government makes you take money out of it every year for the rest of your life. You’ll be hit with a 50% penalty if you don’t make a withdrawal. But that is NOT required with a Roth IRA.

Should the government cap Roth IRA contributions?

If you fall under the income limits, you can contribute $6,000 each per year as long as your earned income is at least $6,000. If one spouse doesn’t have earned income, you can still contribute $6,000 per person (if under 50). If you’re over 50, you’re allowed to contribute up to $7,000 per person.

In his article, “Lord of the Roths,” Justin Elliott shared that in 2018, the average Roth IRA was worth $39,108. In the article, Peter Thiel—the co-founder of PayPal—was highlighted. He has amassed $5 billion inside his Roth IRA. In comparison, at the end of 2018, Warren Buffet only had $20 million in his Roth IRA.

This is not the intended use of the Roth IRA. That $5 billion is growing, earning interest, and protected 100% tax-free. The government has talked about putting a cap on the dollar amount in Roth IRAs. So far nothing has passed but this story may ruin it for everyone.

Details on the Backdoor Roth IRA

If you’re a high-income earner and your household income is well about the $198,000 threshold, you can’t contribute through the “front door” of a Roth IRA. If you’re 50 years old and you want to contribute $7,000 to a Roth IRA, you can use a Backdoor Roth IRA. To do this, you open an IRA and make a non-deductible IRA contribution. What does that mean?

If you contribute to an IRA, you can deduct the $7,000 on your taxes. Don’t do that. Instead, file form 8606. This form lets the IRA know you’re contributing without taking the deduction. You can then immediately convert the $7,000 into a Roth IRA to grow tax-free.

Why I’m passionate about Roth IRAs

A Roth IRA can provide tax-free income in retirement. Why is that important? Social security is taxable. If you have a pension, it’s taxable. A stream of income that is tax-free helps reduce overall taxes in retirement. Your social security and pension wouldn’t be taxed as high as they might be if you’re making withdrawals out of a traditional IRA or 401k. What are other benefits to having a Roth account? Listen to the whole episode to learn more!

Resources & People Mentioned

• Form 8606: Nondeductible IRAs
• Lord of the Roths by Justin Elliott