Is a ROTH right for you?
Posted on December 1, 2015 by bob in MoneyWise
A Roth account is the only income tax-free (not just tax-deferred) account structure available to most people. If you do not have money in a Roth account, keep reading. Even if you are already retired or will soon leave the workforce, you may benefit from a Roth.
Roth Basics
One of the main attractions of a contribution to a traditional retirement account (like a 401(k) or IRA) is that it is deductible on your tax return in the year you make it. A Roth contribution is not deductible. However, withdrawals from a traditional plan are taxable, whereas money taken from a Roth is not if the account has existed for at least 5 years and the owner is more than 59½. Having funds in both types of accounts provides beneficial flexibility in retirement.
New Roth Contributions While Working
Most people can benefit by funding a Roth account during their working years. You can contribute to a Roth IRA or, if you participate in a 401(k) with a Roth option, to that employer-sponsored plan. If you use a Roth IRA, pay attention to the applicable income and contribution limits. If you are over 49 in 2015 you can contribute the lesser of $6,500 or 100 percent of your earned income. You can also fund a Roth for a non-working spouse. Roth contribution availability phases out starting at modified adjusted gross income of $116,000 for single filers and at $183,000 if married filing jointly.
If your income exceeds the limit, you can circumvent the income limit by making a non-deductible contribution to a traditional IRA and then promptly converting it to a Roth, although some tax may apply to the conversion.
Roth Conversions
A Roth conversion takes place when someone with money in a traditional IRA moves some or all of it to a Roth. A conversion may make sense whether you are working or have retired. A conversion is subject to the same income tax that would apply if you simply withdrew the money, except that there is no early withdrawal penalty.
The natural question is, “Why would I trigger income tax sooner than necessary?” Conversions are most advantageous in years when you would otherwise be in a comparatively low tax bracket. As discussed last month, in some years you might pay only 10 percent or 15 percent federal tax on a Roth conversion, whereas you might owe 25 percent or more in some other years. By forecasting your likely tax situation over a number of years, you can choose to absorb the tax hit at the most opportune time. Also, the sooner you fund a Roth account, which starts the 5-year clock, the sooner withdrawals will be tax-free.
Here is a twist on Roth conversions for those interested in maximizing the opportunity. The IRS allows “recharacterizing” a Roth conversion (undoing the conversion) up to the time when you file your tax return for the year in which the conversion took place.
Suppose that you decide $10,000 is the amount you want to convert in 2016 and your investment strategy for your IRA and Roth is half stocks and half bonds. In January 2016, you convert $20,000 and put $10,000 in stocks and $10,000 in bonds. Before filing your 2016 tax return sometime in 2017, you recharacterize (unconvert) whichever $10,000 performed less well, pulling those assets back into your IRA. You only pay tax on a $10,000 conversion and keep the one which provided the biggest benefit on the Roth side of the ledger.
Including a Roth in your retirement plan could meaningfully enhance your situation. As always, you should carefully assess your situation before making any decisions. If you need guidance after doing your own reading and research, seek the assistance of a qualified professional.
Alan Wallace
Alan Wallace, CFA, ChFC, CLU, is a Senior Private Wealth Advisor for Ronald Blue & Co.’s Montgomery office, www.ronblue.com/location-al. He can be reached at 334-270-5960, or by e-mail at alan.wallace@ronblue.com.
