A common planning question we discuss with clients is, 'Could a Roth IRA potentially help me and, if so, how?' Therefore, we thought it might be helpful to discuss this topic in a little more detail.

What is a Roth IRA?

A Roth IRA is an Individual Retirement Account to which you contribute after-tax dollars. While there are no current-year tax benefits, your contributions and earnings can grow tax-deferred, and you can withdraw them tax-free and penalty free after age 59½ and once the account has been open for five years.

What are the Benefits and Drawbacks of Roth IRA Accounts?

The benefits of Roth IRAs can be helpful to your long-term retirement and tax planning.  They include the following:

  • Tax-free withdrawals in retirement.
  • No required minimum distributions or RMD’s.
  • No age limit for contributions.
  • Potential for tax-deferred growth of contributions and earnings.
  • Flexibility in managing and using retirement savings.
  • At death – the value of the Roth IRA is income-tax free to beneficiaries.

While Roth IRAs offer multiple benefits, they have some potential downsides:

  • Contributions are made with after-tax dollars and cannot be claimed as a tax deduction.
  • High income earners may not be eligible to contribute to a Roth IRA.
  • Contributions are limited to a certain amount per year.
  • Withdrawals of contributions are tax-free, but earnings are subject to taxes and penalties if taken before 59 ½, and it must be five years since your first contributed to your Roth.

What is a Roth IRA Conversion?

A Roth IRA conversion is the process of converting assets from a traditional IRA or another eligible retirement account into a Roth IRA.  This conversion is taxed as ordinary income in the year it is made, but all future growth and qualified withdrawals from the Roth IRA are tax-free.  If a taxpayer has traditional IRA accounts that hold both deductible and non-deductible amounts, he or she may not “cherry-pick” and convert only the non-deductible contributions. Instead, the value of all IRA accounts is added together, and a ratio is calculated to determine the tax-free portion of any conversion.

What is a “Backdoor Roth IRA” Conversion?

This strategy allows individuals with high incomes to contribute to a Roth IRA, even if their income exceeds the limits set by the IRS.  This is done by first contributing to a Traditional IRA, and then converting that money to a Roth IRA.  The conversion is subject to income taxes, but it allows you to contribute to a Roth IRA without being subject to IRS income limits.  It is important to note that this strategy may not be suitable for everyone.  Our team can coordinate with you and with your tax professional before completing a backdoor Roth IRA conversion.

“Mega Backdoor Roth IRA” 

This for people who have a 401(k) plan that allows them to contribute up to $45,000 of post-tax dollars in 2024 and then roll it into a mega backdoor Roth.  The caveat: Creating a mega backdoor Roth is complicated and has many moving parts.  If not properly executed, you have the potential to get hit with unexpected tax bills.  Therefore, it is important to plan up front with your accountant and our team to avoid possible issues.

Are There Any Benefits to Roth IRA Conversions in a Down Market?

There are several potential benefits to completing a Roth IRA conversion in a down market:

  • Lower Taxes: As the value of the traditional IRA is lower during a down market, the amount of taxes owed on the conversion may be lower.
  • Potential for future tax-deferred growth on your fund in the Roth IRA account when the stock market recovers.
  • Tax Diversifications: Utilizing a Roth IRA can also provide tax diversification in your retirement income sources.

Does a Roth IRA Conversion Make Sense for You?

Ultimately, the decision to convert to a Roth IRA should be based on your individual specific financial situation, planning goals and tax planning strategies. Our team, in coordination with your tax advisor, can help you evaluate if and how a Roth IRA could potentially benefit you.

If you would like to discuss Roth IRA’s further, reach out to your advisor at Bleakley to discuss if it’s the right fit for you.

Article Originally Posted on 4/14/23 | Revised on 6/25/24

 

John Patterson, Author: Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the CFP® certification mark, the CERTIFIED FINANCIAL PLANNER™ certification mark, and the CFP® certification mark (with plaque design) logo in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements. CA Insurance License #0B85290, AR Insurance License #1393690

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Your financial professional may provide you with investment advisory services, brokerage services or both. Those services and fees differ; therefore, it is important for you to understand the differences. Free and simple tools are available to research firms and financial professionals at the SEC’s investor education website, https://www.investor.gov/CRS, which also provides educational materials about investment advisers, broker/dealers, and investing. You should carefully read the information provided by financial professional that more fully describes the services, fees and costs specific to your situation.

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INVESTMENT RISKS AND DISCLOSURES

Any financial transaction involves a variety of potential significant risks and issues. Before entering into any financial transaction, you should ensure that you fully understand the terms, have evaluated the risks and have determined that the transaction is appropriate for you in all respects. Bleakley makes no guarantee that your investment objectives will be achieved. Past performance is never a guarantee of future investment results. Actual results may vary.

Content in this material is for general information purposes only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. 

All investing involves risk including loss of principal. No strategy assures success or protects against loss. Past performance is no guarantee of future results. There can be no guarantee that any strategies promoted will be successful. Any economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.

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About the Author

John Patterson, CFP®, CLU®

John Patterson, CFP®, CLU®

John is a graduate of Duke University with a B.A. in Psychology and Classical Studies. Upon graduation in 1990, he entered the financial industry. While his initial focus was on the risk management side of financial planning, in 2004 he transitioned his business to incorporate a comprehensive planning approach that integrates both risk and wealth management strategies to help his clients pursue their personal goals. John lives in Atlanta with his wife, Nancy. They have three children, Meg, Jack and Luke. John is passionate about spending time with his family and helping his children grow into distinguished young adults. They love to travel together and create lasting memories. John is an active member of the Holy Spirit Catholic Church and loves participating in various outdoor activities such as fishing and hiking. John is also an avid sports fan and enjoys cheering on the Duke Blue Devils and Atlanta Falcons. John is also a member of the Atlanta Homosassa Fishing Club. John is a current Board Member of The Schenck School, which is a school that specializes in remediating students with dyslexia using the Orton-Gillingham teaching system. This method of learning allows students to reenter mainstream schools within a 1-4 year period of time. In addition, John gives back to his alma mater, Duke University, by interviewing prospective students in the metro Atlanta area who have applied for admission to Duke. Over the course of his financial career John has earned the Certified Financial PlannerTM (CFP®) and Chartered Life Underwriter (CLU®) designations. He currently holds the series 6, 63, and 7 securities registrations held with LPL Financial.