I have a rollover IRA just existing from a previous employer and my brother says I should get it converted to a Roth IRA ASAP. I have no clue what that even means and when I looked it up in here, it’s everyone just talking about what to investments are best for their Roth…so that means I convert to the Roth and have to figure out stocks to put it in? How do I decide what is best? I genuinely know nothing about this.
A Roth works like this: 1. You invest money into it like a regular IRA 2. The IRS will still tax you for the money you invested, unlike a regular IRA 3. However, when you retire and take money out of the Roth, the IRS can’t touch one cent. No matter how much your investments have earned you, it’s all yours to keep!
Basically: you take the tax-hits up front and sail smoothly when it’s time to retire! Whether or not that’s a good fit for you is entirely based on your own situation. :)
To add on to this, since the government is butt hurt they cannot tax you when you take it out, they limit what you can contribute to a Roth IRA in one year. Currently. it's $7,000.00.
Don't traditional IRAs have the same annual contribution limit?
That's correct. The limit is between the 2. So, you can contribute to both a Roth and a Trad IRA, but it can't be more than $7K between the 2 per year.
Luckily it's by the individual, so you can put in 7K and your spouse can do the same. I topped out as of last month so I'm going to start putting some into my wife's Roth so we can retire someday.
It's 8k this year. 8500 over age 50. The same contribution limits as regular ira
Basically with a Roth IRA you're using after tax dollars and taking care of your tax liability up front. This is advantageous as you'll have to pay far less taxes this way.
Please explain why the taxes now are less. Especially for those who are now in a high tax bracket, but expect to be in a low tax bracket when past their 60s in age. Thanks.
Because you've already paid taxes on the money you're puttin in. On a traditional IRA when you pull them out after the money grows which is a much larger some as your investment is expected to grow.
Okay, but i think the devil is really in the details. If I put in 7k now and pay 37%, it will take a spreadsheet for me to figure out where the tipping point is for making that better than putting 7k in with no taxes, and then withdrawing a little bit every year at 10% taxation.
Its not so straightforward as what your brother is saying.
Your normal rollover IRA that you have now is untaxed when you put money in now and is taxed later as income when you get it out (presumably when you retire).
Roth is different in that it is taxed first as income now and then it's untaxed later when you get it out. There are definitely real benefits to this.
This means if you convert your whole IRA to roth now, you'll face a huge tax burden up front because everything you are converting is treated as new income on top of your income you are already being taxed on this year. It could push you into a higher tax bracket on the year and make that money you are converting taxed at a high rate.
The best way to handle it is imo to try to diversify a bit. That way, lets say when you retire, in one year, your normal rollover could pay out 60k in one year, and your roth pays out another 40k, you'll get 100k and only pay taxes on 60k of taxable income. This can keep you in a lower bracket at that time.
So basically you try to plan it such that you keep your "income" both now and when you retire in lower brackets. If your rollover is flush, you may consider trying to convert bits and pieces each year such that you dont push your income into higher brackets. If your rollover is not that loaded, it may not matter much anyway because when you make that "income" after retirement you wouldnt be in a high tax bracket anyway. You sort of have to project out the future and estimate your career earnings to make a good plan.
A Roth IRA is a post tax retirement account that grows tax deferred. Once you reach the age of 59.5 and have had the account (with a contribution) for over five years, the gains on the account are withdrawn tax free.
There’s benefits in doing a Roth conversion. But know that you will pay taxes on converting a (presumably) pretax 401k into a Roth IRA. I’d talk with a tax professional or financial advisor before you make that decision to better understand the tax implications of the conversion.
Traditional IRA is funded with pre-tax money and future withdrawals are taxed. Roth IRA is funded with post-tax money and future withdrawals are untaxed. Converting involves paying taxes now on the money moved over, but makes future withdrawals untaxed. I wouldn’t convert. I have a suspicion the government may renege on the tax free status of Roth withdrawals in the future.
For retirement accounts, there are two basic types: traditional and Roth.
For a traditional retirement account, the money is taken out pre-tax. So if I make $100,000 and I take out $10,000 a year for my IRA, and my tax rate is 20%, I am only taxed 20% on the $90,000 remaining after withholding for the IRA, so I pay $18,000 in taxes and take home $72,000. Then, when I retire and withdraw money from the IRA, I am taxed on that as income.
For a Roth IRA, you pay the taxes upfront. So with the same $100,000 and $10,000 withholding, I am taxed 20% on the full $100,00, or $20,000, and have a net take-home pay of $70,000. The benefit that I get in return is that, when I retire and withdraw money from the Roth IRA, it is not taxed as income as taxes have already been paid on it.
If you take money from a traditional IRA and roll it over into a Roth IRA, you will need to pay taxes on that amount as you roll it over, meaning either some of that money doesn't make it into the Roth IRA or you have to pay out of pocket.
As for which one you should prefer, that's going to depend on some factors. Are you close to a tax threshold? Taxes in the US at least are graduated, so you pay a certain percentage on your first so many dollars made and a higher percentage on anything after that. If you're making $200,000/year as a single taxpayer, it might make sense to withhold ~$9,000 for a traditional IRA as anything over $191,950 is taxed at 32% as opposed to the 24% that you are making between $100,525 and $191,950 so you get less of that last bit of money if you don't withhold it.
Another factor to consider is whether you believe you'll be paying a higher tax rate in retirement or currently. For most people, it's likely that you'll be paying lower taxes in your retirement years as you won't be working a full career at that point, but if you expect to have a high enough income in the near future that you'll have a lot of investments paying out in the further future, that may not be true. You may also suspect that tax rates will need to increase over time to compensate for federal deficit, so taxes right now are probably lower than they'll be in 40 years.
Traditional IRAs and Roth IRAs are both retirement savings accounts with favorable tax treatment, but with different timing.
First, with an ordinary investment account, you can only invest money you have already paid tax on, and earnings are taxed as you go (interest and dividends immediately, capital gains when you sell the stock).
With a traditional IRA, the money you invest is tax deferred (you get a deduction in the year you contribute), and taxes on the investment profits are also deferred. You pay all the taxes when you withdraw the money. The 401(k) plan from your work follows the same rules, so when you change employers, the account is set up as a traditional IRA.
A Roth IRA (named for the senator from Delaware who introduced the law creating them) has its tax benefits on the far end. You get no deduction going in, but withdrawals are not federally taxed. Thus, the investment profits are never taxed by the feds (they may be taxed by a state).
A “Roth conversion” means you pay the tax on all or part of your traditional-IRA balance in the year(s) that you do the conversion, and get the future benefits of a Roth on that money. I say years, possibly plural, because you can convert part of the account in one year and part in another. This can be useful if your tax bracket would be affected.
Both plans have their pros and cons. Your best bet is to put your questions to the bank or investment house that is holding your IRA (they have experts on the tax and investment consequences, and are the only ones who know the mechanics of how a conversion is handled within their firm). If you already have your own tax pro, ask them too.
If you keep your Investment Retirement Account (IRA), all that money had been added to your 401K without being counted as income for tax purposes. You basically can leave the money as an IRA and it will grow without it being taxed. You are deferring your taxes until later. When you retire (age 59 1/2 is the government age for that purpose), you’ll get taxed on the money you withdraw from the IRA like any income. In theory, you’ll have less income in retirement so you’ll be at a lower marginal income tax rate so it’ll save you money because you are paying less in taxes plus all that money you would have paid as tax has been accumulating and earning more money.
If you want to flip into a Roth IRA, you’re changing the dynamic in one key way…. You go ahead and pay the taxes on all the money you have in your IRA at your current marginal tax rate. But as long as you adhere to the requirements; which generally means you have it in there for at least five years and don’t withdraw before you’re 59 1/2 years old, no matter what you earn, it is tax free.
So this is what you need to figure out; what makes more sense for you?
Do you have the money to pay the income taxes on all of your rollover IRA money?
Do you have enough time that you’d make a lot more from your investments to make up for what you had to pay now in taxes?
Will your tax rate when you are in retirement be high enough that withdrawing some of your IRA hurts if you have to pay taxes on it?
You might be able to just move a portion of the IRA to Roth, but that’s where an investment advisor would come in.
You eventually will want to retire from working. However, that means you need to get money to live from somewhere other than your job.
Almost every American pays into Social Security, with the current average payout being $1975/mo aka $23700/yr. That’s nowhere near enough for most people.
So, that’s where saving for retirement on your own comes into play. You can save in a savings accounts or in CDs, but those are risk-free which means not huge growth, that’s where stocks come into play.
You can invest in a normal account, but the government actually gives you a tax break if you use a retirement account, in the form of a 401(k), 401(a), 403(b), 457(b), TSP, IRA, etc.
A 401(k) is thru your employer, an IRA is usually on your own (small business IRAs exist).
Retirement accounts can be Traditional or Roth. Traditional means no taxes now and pay taxes in the future, Roth means pay taxes now and no taxes in the future. Which is better for you depends on your tax brackets now vs in the future, so that’s going to be based on your income as well as how much you’ll withdraw (someone making $200k but lives a frugal life most likely is better off doing Traditional), but it’s also based on the tax brackets set by the government and those could become more or less favorable for your income level in the future.
Roth IRAs are more popular than Traditional IRAs because more people qualify for them. For a Traditional IRA, you are disqualified from getting the tax deduction if you make too much while you have a job that offers a 401(k) ($87k if Single and $143k combined if Married Filling Jointly). Roth IRA disqualification happens at $146k is Single.
401(k)s usually come with an employer match, so free extra money. It is advised to setup your contributions to get the most of that match and then excess goes towards a Roth IRA, mainly because 401(k)s have limited choices and can have management fees whereas Roth IRAs at large brokerages have no management fees and there are no limits compared to a normal stock account.
It is advised the average American should be saving at least 15% towards retirement if starting at 25 and retiring at 67 and living an average life. Say you make $100kk and the employer match is $1:$1 and maxes out at 4%, then that means to do at least 4% towards 401(k) and 7% towards IRA (IRA limit for 2025 is $7k).
A Rollover IRA means you had a 401(k) at your old job and instead of leaving it as-is or combining it with the one at your new job, you converted it to an IRA to manage it. It already has stocks/bonds purchased in them, which ones would determine whether you can keep them or if you need to “cash them out” and choose new investments. Obviously, which investments are best is something nobody knows, and if you want to be hands-off you can choose a Target Date Fund (assuming low fees) where the year in title is around your estimated year of retirement, so if you are say 27 then age 67 would be 2065 and you’d get say FFIJX if using Fidelity or say VLXVX if using Vanguard. I personally am doing about the equivalent of 80% VTI and 20% VXUS.
So what about a Roth 401k? I've had that option from my employer's 401k program, and i'm just slamming my retirement into that currently. It shows that i could contribute the same 23,500 i could to a traditional 401k, but i'm assuming i'm just being hit for that taxable income now.
The limit is shared between the 401(k)s.
Besides whether you are paying the tax now or later, you also have to think about deductions. There may be some tax deductions you currently take but phase out at higher income levels, and if you do a Roth 401(k) your taxable income level is not lowered and thus you may no longer qualify.
Since normal IRA limits are only $7k, usually that amount isn’t enough for most people to get phased out of deductions, but for people who max out, or close to, their 401(k), you have to be more aware.
Yeah my Tax level is unaffected by the 23,500 limit by doing a Roth 401k, which is nice, because I was planning to split the two for tax purposes, but it doesn't really matter where my income level is currently (thankfully) And speaking with a few others basically say, do it now, because you don't know what tax rates will be like in 20 or so years.
Yeah, I like Roth because the tax is certain.
Just double check as things like child tax credit, student loan interest deduction, etc. phase out at higher taxable incomes.
A Roth IRA is a gamble that a future Congress will honor a tax deal made by a previous Congress.
In a regular IRA you put in money before it's income taxed, and when you take that money out you pay income tax on whatever you withdraw. Essentially you are "getting paid" when you take money out of a traditional IRA. Ideally when you do that you'll be in a lower tax bracket than you were when you earned the money you deposited, and the IRA will have gained in value over the time the money was in it, so you'll come out ahead vs. just putting the money in a savings account.
A Roth IRA is a gamble. When you use a Roth, you put after-income tax money into the Roth IRA. And, if you win the gamble, when you withdraw it you don't pay any tax. If your money grew while it was in the Roth, you're essentially going to get untaxed income in the future. Depending on what you think the future is likely to be and how much you are likely to earn on your Roth's investments, that may be a good deal.
If you lose the gamble, a future Congress under pressure to fund the government due to catastrophic problems with it's fiscal policies decides to tax the money anyway and tells you "pray they don't change the deal further" if you complain.
I have friends who have decided that the risk of the Roth is so high that they refuse to use them and always use a traditional IRA.
Let's say you have $100,000 in your rollover IRA and it grows to $1,000,000 when you retire. When you take the money out, you will pay taxes on it. Say those taxes are 25%. You will receive $750,000
If you convert to a Roth IRA now, you'll pay taxes on the $100,000 today. Assuming the same 25%, that leaves you $75,000, which will grow to $750,000 in retirement, but you won't pay taxes when you take it out.
Now, if your current rate is only 20% and you think the rate in retirement will be 25%, then you're better off converting now. If your current rate is 25% and you think your rate in retirement will be 20%, then you're better off waiting
(It's more complicated than that, but that's the very basic idea.)
THAT. That is where my reasoning falls apart. HOW can one know what the tax rate will be 20 years in the future? How can one make an educated guess as to whether a Roth is worth it or not?
(I assume you mean tax rate and not interest rate ... though, interest rates should probably be part of the calculation too).
You're right: impossible to know. Congress could suddenly get serious about the budget defecit and double the tax rates.
One strategy is to do a partial conversion. The Roth IRA money taken out won't be taxed and that will reduce the marginal rate for the traditional money that isn't.
You don't. But you begin this journey with the understanding that, in general, taxes are always going to go up or stay generally the same. At the levels we are talking about, there generally isn't massive change to the tax structure and it's a safe bet to assume they'll be similar or higher than they are today. You use this assumption to make the determination of a Roth is "worth it" to invest in. And again, generally, as most anyone would tell you, it is better to pay the tax today and not have to worry about it in 20+ years, and have an entirely tax free account.
That's also why having a Roth is only part of a balanced retirement portfolio. A good retirement plan has contributions to a 401k or traditional IRA that may gain money faster (as it is pre-tax, so higher starting balance), but you're right, there's a (very small) chance you could pay less taxes in the future and that 401k/IRA will have more "current value" at that point in time.