6 FAQs About Roth Retirement Accounts
Money Girl answers six Roth FAQs from readers and podcast listeners to help you understand how to use them to invest for retirement. Plus, she explains the best places to open up your Roth retirement account.
If you’re familiar with Roth retirement accounts, but still have questions about how they work, you’re not alone. Although the rules can seem confusing, it’s worth your time to understand them because Roth accounts are loaded with money-saving benefits.
In this episode, I’ll answer 6 top Roth FAQs from Money Girl podcast listeners and readers and tell you the best places to open up a Roth IRA.
Also see: Award-Winning books, audiobooks, and e-books written by Laura
Why You Should Use Retirements Accounts
The reason retirement accounts are such a big deal and should be a cornerstone of your finances is because they offer huge tax benefits. By cutting taxes, you keep as much of your money invested as possible, so your account earnings are as big as possible.
The bigger your account earnings, the more income you’ll have to spend in retirement, so you can enjoy the lifestyle you really want.
If you invested the same amount using a Roth IRA instead, you’d have over $1.5 million, or an additional $600,000 to spend in retirement!
Let’s say you begin investing for retirement when you’re 25 years old using a taxable, non-retirement brokerage account. If you contribute $5,000 every year until you retire at age 70, and get a moderate average return of 7%, you’d accumulate about $900,000.
While that sounds terrific, consider this: If you invested the same amount using a Roth IRA instead, you’d have over $1.5 million, or an additional $600,000 to spend in retirement! That’s the difference using a tax-advantaged retirement account can make in your life. I’ll explain how they work in just a moment.
See also: 10 IRA Facts Everyone Should Know
What’s the Difference Between Traditional and Roth Retirement Accounts?
There are many different types of retirement accounts for individuals, employees, and those who are self-employed. But they all fall into one of two main types: traditional and Roth.
- A traditional retirement account, such as an IRA or workplace 401k, allows your investment to grow tax-deferred. That means you don’t pay tax on your contributions or earnings until they’re withdrawn. You generally can’t withdraw money until you reach age 59½ without paying income tax plus a 10% early withdrawal penalty. But you must begin taking withdrawals after you turn 70½—unless you have a workplace retirement plan and are still working.
- A Roth retirement account, such as a Roth IRA or Roth 401k, allows your investment to grow tax-free. You pay tax upfront on your contributions, but owe no additional tax on contributions or earnings when you take withdrawals, as long as you’ve had the account for five years. With a Roth, you’re never required to make withdrawals, so you can contribute after age 70½ and your account can grow tax-free for your entire life. The only limitation is that if you exceed an annual income threshold you become ineligible to make contributions. I’ll explain more in one of the Roth questions that we’ll cover.
Free Resource: Retirement Account Comparison Chart (PDF download)—a handy one-page reference to understand the pros and cons of different types of retirement accounts and the best places to get them.
5 Roth Frequently Asked Questions (FAQs)
Now that you know the basic differences between Roth and traditional retirement accounts, here are the answers to 5 FAQs about Roths:
Roth Question #1: Christine asks, “I’m 34 years old and have a traditional rollover IRA of $65,000 from a retirement account with a previous employer. I believe that having a Roth IRA would be a good option for me. Should I covert my traditional IRA into a Roth IRA or just start feeding a new Roth account?”
Answer: Since funds in a traditional retirement account are pre-tax and those in a Roth must be post-tax, making a Roth conversion means you’ve got to settle up a tax bill with the federal government.
For instance, if Christine’s average income tax rate is 25%, she’d owe $16,250 ($65,000 x .25) in taxes for the year she makes a Roth conversion. In other words, if she converts $65,000, that amount gets included in her taxable income for the year. That’s quite a tax hit.
Let’s say she doesn’t have $16,250 in savings or non-retirement investments and has to tap the IRA to pay the conversion tax. In that case, she’d also have to pay an additional 10% early withdraw penalty since she’s younger than age 59½. Not a good idea.
So, my recommendation is not to do a Roth conversion. As long as your income is below these limits for 2015 you can open up a Roth IRA and begin making contributions:
- Married filing jointly or qualifying widow(er): $193,000
- Married filing separately: $10,000
- Single or head of household: $131,000
And by the way, even if your income is too high to contribute to a Roth IRA, there’s still a way to create one, which is called a backdoor Roth. To learn more read or listen to 5 Steps to Create a Backdoor Roth IRA.
Roth Question #2: Tatiana asks, “My company 401k doesn’t have a Roth option, but I’d like them to offer one. If they adopt a Roth, do they have to drop the traditional 401k or the company match? And what’s the best way to approach my employer about this?”
Answer: More employers are adding the Roth option to their retirement plans. Unlike a Roth IRA, with a Roth 401k or 403b, there’s no annual income limit you have to stay under to qualify, which is a huge benefit. So, those income cutoffs that I just mentioned for a Roth IRA don’t apply to a Roth account at work.
Companies that establish a Roth have to offer it in addition to a traditional retirement account, not in exchange for it. And the two accounts must be kept completely separate. You can contribute to either a traditional 401k, a Roth 401k, or to both.
Having a Roth doesn’t affect an employer’s ability to offer a match; however, those contributions must always go into your traditional 401k on a pre-tax basis, instead of into your Roth account.
To lobby for a Roth 401k at work, I’d ask your benefits administrator or human resources contact if they have any future plans to add a Roth. By his or her response, you can gauge what they know about these accounts or any changes that may already be in process.
Many companies also have an annual benefits meeting or webinar where you can ask questions. That’s a great time to publicly express interest in expanding your retirement benefit to include the Roth option.
See also: 7 Pros and Cons of Investing in a Retirement Plan at Work
Roth Question #3: Joe asks, “Can I contribute to a Roth IRA in addition to a traditional IRA?”
Answer: You can contribute to both a traditional IRA and a Roth IRA in the same year, as long as you don’t exceed the total annual contribution limit. For 2015, you can contribute a total of $5,500, or $6,500 if you’re over age 50, to one or both accounts.
For example, you could contribute $2,000 to a traditional IRA and $3,500 to a Roth IRA, or any proportion you like. But as I previously mentioned, to make contributions to a Roth IRA, you can’t exceed annual income limits.
If you become ineligible to contribute to a Roth IRA in the future, it’s not a problem. You can still manage your investments the same way.
If you become ineligible to contribute to a Roth IRA in the future, it’s not a problem. You can still manage your investments the same way. And if your income falls below the annual limit down the road, you can begin contributing again.
See also: How to Invest Money in Your IRA or 401k Retirement Account
Roth Question #4: Adam asks, “Can I contribute to an IRA in addition to my retirement plan at work?”
Answer: When you have a retirement plan at work you can also contribute to a traditional IRA, a Roth IRA, or to both. However, there’s a downside you should know about. If you earn over an annual threshold, the tax deduction for your traditional IRA may be limited.
Here are the 2015 annual income limits for getting a full deduction from a traditional IRA when you also have a retirement plan at work:
- Married filing jointly or qualifying widow(er): Up to $98,000
- Married filing separately: Up to $10,000
- Single or head of household: Up to $61,000
If your modified, adjusted gross income is higher than these amounts, you can still contribute to a traditional IRA. However, you may get a partial or no tax deduction.
There’s another restriction if your spouse has a retirement plan at work but you don’t, and you contribute to a traditional IRA. In that case, you can only get the full deduction if your household income is less than $183,000.
Again, if your income is higher than these annual limits, you can still contribute to a traditional IRA, but you won’t get to claim the full tax deduction. None of these limitations apply to a Roth IRA because those contributions are not tax-deductible.
As long as you don’t earn too much to contribute to a Roth IRA in the first place, you can max out both a Roth IRA and a workplace retirement plan every year and get 100% of the tax benefit.
See also: The Rules for Using a Spousal IRA
Roth Question #5: An anonymous podcast listener asks, “Can I roll over my workplace retirement account at a previous employer into a Roth IRA?”
Answer: You can only roll over workplace accounts into like accounts without triggering a tax consequence. For instance, you can roll over a traditional 401k into a traditional IRA and a Roth 401k into a Roth IRA.
Moving money from a traditional workplace account into a Roth IRA would be considered a Roth conversion. As I mentioned in the first question above, I generally don’t recommend doing that since it can be a huge amount of additional income tax to pay.
Free Resource: Laura’s Recommended Tools—use them to earn more, save more, and accomplish more with your money!
Roth Question #6: A basic question that everyone should know is, “How much can I contribute to a Roth 401k?”
Answer: The combined amount that employees can contribute to their Roth or traditional workplace plans for 2015 is $18,000, or $24,000 if you’re age 50 or older.
You can max out either type of account or split your contributions between them in any proportion, as long as you don’t exceed the annual allowable limit.
Since taxes are one of the biggest expenses we have, using a variety of retirement accounts is a terrific way to cut your taxes. Traditional accounts let you cut them now and Roth accounts allow you to cut them in retirement.
Both a Roth 401k and a Roth IRA are smart choices for young people who are making less money and are in a lower tax bracket now than they’re likely to be in the future. But even if you make too much for a Roth IRA, the Roth 401k is still a great option for older, higher paid workers who want to avoid a huge tax bill in retirement.
Here are some of my favorite places to get a Roth or a traditional IRA:
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About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.
