Retirement Answers

Jacob: 00:01

You could get potentially tax free growth in the future because there is a five year rule on the growth. If you want to access the principal, what you've contributed to your Roth IRA, you can do that at any point. There's no rules or restrictions on taking the money out that you've actually put in. Welcome to Retirement Answers, a podcast built to answer your most pressing retirement questions. If you're someone who's either thinking about retirement or already in retirement, well, you're in the right place.

Jacob: 00:31

Hey there. My name is Jacob Duke, and each week, I'll be walking through different tips and strategies to help you succeed in retirement. So let's go ahead and get started with today's show. Hey friends, and welcome back to another episode of Retirement Answers. My name is Jacob Duke.

Jacob: 00:49

I am your host as always. I'm glad that you're here. And today we are gonna be talking about five different benefits of having a Roth IRA or using a Roth IRA in your retirement years. So we're gonna talk through those benefits and then we're gonna talk through some of the ways that you can help maximize your Roth IRA in retirement. Now, how can this be helpful for you?

Jacob: 01:08

Well, if you are still before retirement, meaning you're in your savings years, you're actively working, you're trying to build up your retirement nest egg, use these ideas or these thoughts to your advantage so where you can say, hey, maybe I should be building up that Roth a little more aggressively because of those potential benefits in the future. Or if you are already in retirement, can say, hey, how can I actually get more money into a Roth? Or what are the benefits of doing some of these strategies to help maximize the potential of my Roth IRA? So before we jump into kind of some of these benefits or ways to help optimize it, wanted to talk really quickly about what a Roth IRA is and some of the different rules around it. Well, in general, a Roth IRA is an account that you put money into on an after tax basis, meaning you pay your income taxes on those funds whenever before you put the money in it.

Jacob: 01:55

So you're not getting a tax deduction in the year in which you make that contribution. But the benefit of the account is that you could get potentially tax free growth in the future. Now, why do I say potentially? Well, because there is a five year rule on the growth. So, just know that if you want to access the principal, what you've contributed to your Roth IRA, you can do that at any point.

Jacob: 02:18

There's no rules or restrictions on taking the money out that you've actually put in. So, if you put $5,000 in, you can take that $5,000 out at any given point. What is restricted is the growth on that $5,000 and that's what that five year rule applies to. So just know that if you put money in and it grows, you cannot touch that growth until five years down the road. After that five years, that money is penalty free.

Jacob: 02:43

But there's another catch here. You have to have five years and be 59.5. So if you have the five years, but you're only age 40, you can still not access that growth without paying a tax or penalty on it. So just know there's a five year and a fifty nine and a half stipulation on the growth within that Roth IRA, but you can always access the principal or what you've contributed to the account at any point. No rules, no restrictions.

Jacob: 03:09

Now there is something else to know here. The order in which you distribute money out of your Roth IRA is going to be the same every single time. So what is the order or the way in which that money comes out? Well, the first thing you should know is that anytime you contribute money, that is gonna be the first dollars to come out. So if you've contributed $50,000 to your Roth IRA over time, and now you have $75,000, in that account because of some growth that's happened.

Jacob: 03:34

Well, the 50,000, if you wanna take money out, that's what you're pulling from first. You're never pulling from the growth first, you're always gonna be pulling from the contributions or your principal first. So that's the first thing to know. The five year rule is sometimes something that a lot of people get hung up on in terms of, I don't want to add money to my Roth IRA because I can't get to it because of the five year rule and all these different things. But just know that I've rarely ever seen someone actually encounter using or having to go against that five year rule because you're actually going to be taking money out of the principal first.

Jacob: 04:05

And most people are never gonna draw down their Roth IRA that much to where they exceed how much they put in and then have to start dipping into the growth. So just know that the order in which the distributions come out is important and does play a factor here. So the Roth IRA five year rule is really not something that a lot of people end up running into. So don't be discouraged by that rule and not contribute to a Roth IRA because of it. Just know that you're probably never gonna run into that issue, even though that rule is there.

Jacob: 04:31

So that's what a Roth IRA is. It is a tax free growth opportunity within that retirement account with a few different rules attached to it. Now, one of the things here that a lot of people get hung up on is they say, if that's an opportunity, I need to go put as much money into my Roth IRA or my Roth four zero one ks as I can because that's the best way to go. And that might not be wrong, but also a Roth might not be the best option for everyone because of your current income or your current income tax situation. If you are earning a high income every single year, it might be more beneficial to actually put that in the tax deferred side, take the tax deduction in the year in which you're earning your income so that you can take the money out of that tax deferred account, perhaps at a lower income tax rate in the future.

Jacob: 05:14

But that's all dependent on your income. So just know that a Roth IRA is powerful. And for a lot of you, the Roth IRA in the early or the savings period of your life, whenever you're accumulating assets, will be a powerful tool in terms of building up that tax free asset for the future, but it's not for everyone. So just know that your income will dictate whether or not you should or should not actually contribute to a Roth IRA. And some of the implications there would be is that you could be paying more income taxes while you're saving into the Roth IRA than you ever would be paying in the future if you were distributing from a traditional IRA.

Jacob: 05:50

So your income could be too high to justify saving into that Roth. So that's just a quick overview of Roth IRAs. With all of that covered, let's talk through some of the benefits of having a Roth IRA in your retirement years. So the first benefit of a Roth IRA here in retirement is going to be that you can have tax free income. Most other sources of income are gonna be taxable, such as distributions from your IRA, your 401ks, any sort of employer plan that are tax deferred.

Jacob: 06:18

You can take money from that account, but it will be taxed as normal income. Also, you might have pensions or some sort of fixed income that might be coming to you. That is also gonna be taxed as normal income. And then also finally, depending on your income or your provisional income, your social security might end up being taxable as well, up to a maximum of 85% of your social security could be taxed. If you have a lower income, it might be less than that.

Jacob: 06:42

And so, all of those different sources are taxable perhaps in slightly different ways, but they are taxable. A Roth IRA comes in and you can take money from that account and pay no income taxes, and also it does not offset some of the other things that we're going to talk about in just a minute. So that's number one benefit of a Roth IRA is that the income from it that you would pull out of the account is going to be tax free, and that is going be really powerful. The second benefit here of a Roth IRA, perhaps in retirement, is whenever one spouse is still working and one is already retired. A lot of people think that once I am no longer earning an income, I cannot contribute to a Roth IRA, and that is not correct.

Jacob: 07:19

There is still the spousal Roth IRA or spousal IRA option to where if you're married filing jointly, you can actually contribute based on one person's income. So let's say that one spouse is still working and earning more than whatever the maximum contributions are for each person to a Roth at that particular time in that particular year, then both people can contribute to a Roth IRA and start and help build their Roth assets. So even if you're not working, you can still contribute based on your spouse's income, assuming that their income is enough to help contribute that money to your Roth. So, the spousal IRA rule and the provision that comes with that allows you to continue saving to a Roth IRA even if you're no longer working. So, just know that that's an option before retirement, but still it's an option after retirement.

Jacob: 08:05

Sometimes folks who are, whether it be a stay at home parent, you might not have an earned income, even though you're doing, I would say, very hard work. If you're raising kids or whatever it might be, you're doing very hard work, but you're not earning an income for that. So, what you can do is, if your spouse is earning an income, you can also contribute to a Roth IRA through that spousal provision. So, the same thing applies in retirement. If one person is retired and the other person is still working, you can both contribute to a Roth IRA.

Jacob: 08:33

So that's the second way that you can use a Roth IRA and benefit from it in retirement. Even if you're not working, you can still contribute if your spouse is earning enough income to justify adding money to that Roth on your behalf. The third benefit of having or using a Roth IRA for your retirement savings is that there are no RMDs or Required Minimum Distributions. That means that unlike a traditional IRA or a traditional four zero one ks, you do not have to take any money from your account ever regardless of your age. Those other two account types, traditional or tax deferred accounts, such as IRAs and 401ks, they have to begin taking money out depending on your age, whether you're 73 or 75, kind of depends on your birth year, but you will have RMDs or Required Minimum Distributions on those tax deferred accounts.

Jacob: 09:18

But remember, a Roth IRA is a tax free account. So the government or IRS does not make you or force you to take money from those accounts depending on your age. So that goes for Roth IRAs, but more recently, the Roth four zero one ks has been added to that. Now that's due to the Secure Act 2.0 that just changed a few things there. But just know that if you have a Roth four zero one ks, you do not have to take money out of that as well.

Jacob: 09:43

So Roth IRAs and Roth 401ks fall into the same camp here of having no RMDs, which the power in that is that you are not going to be forced to pay income taxes on assets or income that you may not actually need. A lot of people end up, especially if they have a pension, end up not needing to take as much money from their portfolio, especially later in retirement, because they have a pension, they might have social security, or maybe some other sources of income that meet their normal daily needs. And so whenever these RMDs start to kick in, what happens is, is they've already got their income needs met, but now they have this other source of income coming into their account every single year because they're forced to take that money out, which means they're going be paying income taxes even though they may not need the money. So a Roth IRA helps eliminate or prevent that risk of taxes in the later years of your retirement because you're not going to be forced to distribute those funds like you would if you had a traditional IRA. The fourth benefit of having a Roth IRA in your retirement is going to be that the distributions, remember they are tax free, but they're also not included on your provisional income, which is the calculation used to help determine if your Social Security will be taxable.

Jacob: 10:52

So if you distribute money from a Roth IRA as income for yourself for whatever reason you would like, you can take that money out. It's not going to go into your normal income tax return, but it's also not going to be included in your provisional income. Now, does that mean? Well, it means that you can have income to live on from your Roth IRA and that does not count against or does not get added back into that provisional income calculation, which means that you can pay a lower tax rate on your social security or perhaps no taxes at all. The opposite of this is if you have only a traditional IRA, then you will have to pay normal income taxes on that distribution like you normally would.

Jacob: 11:30

But also that distribution amount is gonna be included in the provisional income calculation, which could increase how much income tax you're gonna have to pay on your social security. So just know that your provisional income is not impacted or not increased because of Roth IRA distributions, and that is an important factor whenever you're thinking about your total tax and how to lower your overall tax bill throughout the rest of your life. So having a Roth IRA in your pocket, being able to pull that money in different situations or as you'd like to, allows you to keep your social security taxation a little bit lower than if you did not have that Roth IRA. And the fifth benefit of having a Roth IRA in your retirement portfolio is that the distributions again are not taxable, but they're also not included whenever we're trying to figure out if we're going to have IRMA surcharges on our Medicare insurance premiums. So remember, just like I mentioned in point number four, provisional income is not impacted or increased based on Roth IRA distributions, but neither is your IRMA surcharges and the calculations that go in determining are you going to have to pay a higher premium on your Medicare.

Jacob: 12:35

And so what begins to happen here, maybe what you're seeing is that whenever you have a Roth IRA and can distribute that money tax free to yourself in retirement, it impacts more than just your normal income tax. It impacts so many other things that are retirement related, such as your Social Security taxation, but also your Medicare premiums and potential surcharges through IRMA that you might have to pay there. So having this is a huge benefit. Having the opportunity to pull that money from a Roth IRA is huge. So what are some ways that you can help maximize the benefits of a Roth IRA?

Jacob: 13:06

How can I make sure that I'm using it to its full potential and not giving up some opportunities there? Well, the first thing that I can think of is most of the time you're not gonna wanna pull from that Roth IRA in the earlier years of retirement. Now, there's gonna be some instances where it might make sense, especially if you're retiring before 59.5 and your Roth IRA is your only option outside of a tax deferred account, which would come with a penalty, to take money before 59.5. Remember your Roth IRA, you can take money out, tax penalty free whenever you're taking out those, the principal or the contributions that you have made. But typically taking money out of a Roth IRA early on is gonna be, not as helpful as opposed to letting that money grow.

Jacob: 13:49

Because remember, the most powerful part of a Roth IRA is the tax free growth. So if you take that money out, it is not compounding any more tax and penalty free. So the longer you can leave that money in, the longer it can grow and be a larger tax free benefit for you, your spouse, or perhaps your grandkids one day. So one thing that a lot of people end up doing here is the Roth IRA is going to be the last account that they ever pull from, or they may never actually, pull from that account in the future because it ends up being the account they, want to actually leave to their kids or grandkids. And what happens is, is you leave them a tax free benefit or a tax free inheritance.

Jacob: 14:28

And that is a powerful thing. If you think about leaving a traditional IRA to a child of yours, that means that they're going have to distribute that money due to the SECURE Act over a ten year period. And if they're earning a really good income over those ten years, the amount they're gonna be distributing and forced to take out is gonna be done at a higher tax rate because of their current income. As opposed to if they receive a Roth IRA, they have to distribute that money by the end of that tenth year, but the distributions are not taxable. So you're getting tax free inheritance to your heirs or whoever is going to receive that money in the future.

Jacob: 15:02

And that is a huge benefit for them. So if that's important to you, just know that your Roth IRA might not be something you actually use for yourself if you have other savings that are adequate, for your retirement income. So that's one way that you would say, hey, want to either delay taking money out of my Roth or just push that for, you know, down the road and not actually dip into it ever. But another reason you might not want to do it is because if you're going be taking money out of your traditional IRA or your tax deferred assets, you might want to do that, instead of the Roth because your income from the time that you retire until you start social security or until your RMDs will kick in, your income is going be as low as it might ever be again. So you might want to use the lowest side of those tax brackets by taking money from the taxable source, such as your tax deferred IRA.

Jacob: 15:48

You might want to take it out during those years, what we call the gap years. I spoke on this last week on podcast. But we might want to use those years to take money from the taxable sources so that we can pay a lower tax rate as opposed to taking money out of the Roth first, pay no income tax, which feels really good, until we get a few years down the road and we're gonna end up paying a really high tax rate because we have really high tax deferred account balances, but also we have other sources of income at that time as well. So, most of the time it's gonna be most beneficial to delay taking money out of your Roth if you can, and it helps you with your inheritance that you're gonna leave to kids or grandkids one day, but then also helps you lower your tax bill throughout your life if you can live on other sources of income that may be taxable, but you can live on them at a lower tax rate in the early stages of retirement. The next way that you can maximize your Roth IRAs is to do Roth conversions in the early stages of your retirement or your gap years.

Jacob: 16:43

I referred to this last week on the podcast, but using a Roth conversion to your advantage could be instrumental in saving perhaps upwards of hundreds of thousands of dollars in taxes over the rest of your life. The purpose of doing a conversion is to get money into that tax free source, but really it's about lowering your RMDs for the future, your required minimum distribution. So what are kind of my general rules here? If I've got assets of north of 1,000,000 in tax deferred sources, I would say that Roth conversions are probably going to be something you need to really evaluate. If you've got 500 to 1,000,000 in tax deferred sources, then you might be in that maybe range.

Jacob: 17:22

Like it might be beneficial, but it's really going be a situational type analysis that will need to be done. If you are under 500,000 in tax deferred account balances in your IRAs or four zero one ks, then Roth conversions might not be helpful for you. Another factor here is gonna be, do you have a lot of fixed income that is taxable such as a pension? Let's say you retire at 60 and, you have a $8,000 a year pension, you're not taking social security yet, and you're single, let's say. Well, you might not have any room in any decent tax brackets to actually do conversions.

Jacob: 17:54

So we have to evaluate, is it worth it to do the Roth conversions or not? But just know that Roth conversions for a lot of folks who have a million or more in dollars saved in tax deferred accounts are gonna be powerful in the fact that they could save you upwards of hundreds of thousands of dollars in taxes over your lifetime. So that's another way that you can optimize or maximize your Roth IRAs and use them to your advantage. You can lower your overall tax bill throughout the rest of your life and build up a larger tax free benefit for you, your spouse, or your kids, or your beneficiaries one day as well. And the final way that I think you should use your Roth IRA and help maximize that is by investing it correctly.

Jacob: 18:32

All too often, I see that people are not investing their Roth IRAs aggressively enough, meaning they might have cash or money markets or bonds or something that will not grow as much over time, they have that in their Roth IRA, but it's not helpful, right? Because if we're not going to use our Roth IRA very soon, it's going to be one of the last assets or accounts that we touch, then we might want to leave that in the, what I call the growthiest assets or investment types. And that way we can grow tax free as much as possible. So that's the, again, the power of that account type is you want to be able to grow it as much as possible. So how does this come up?

Jacob: 19:07

Like what are the common mistakes I see here? Often I see that a lot of people end up having, let's say seventythirty portfolio asset allocation across the board. Well, they might have a brokerage account, a Roth IRA, and let's say a traditional IRA and all three account types are seventythirty across the board. So that's one way that I see that's an issue. But instead, what I would say is we need to focus on what's called asset location, meaning we should probably invest each account type differently based on how those account types are taxed.

Jacob: 19:36

So in that example, a Roth IRA, which is tax free growth moving into the future, you'd probably want to invest that more like 100% stock so that you can get the highest growth potential. Also on your brokerage account or your taxable investment account, you would maybe not want to hold fixed income assets if you can avoid it. You would want to hold your things that have long term capital gains or qualified dividends such as stocks so that you can pay a lower tax rate every single year. Whenever you receive your $10.99, you have less income, and whenever you do have that income, it will be at a lower tax rate than if you have income from say bonds, CDs, or treasuries that would be taxed at higher tax rate because that would be falling on as a normal income. So that's some ways to think about how you can maximize it, but I would suggest maybe looking at your investment portfolio and seeing, hey, how can I use the account type to my advantage based on how it's taxed to make sure I'm investing these accounts differently as opposed to the same across the board?

Jacob: 20:34

That's a common mistake. And investing your Roth IRA as aggressively as possible is going to be a way to help maximize the benefits of it. So with that, I hope that this has been helpful for you in understanding some of the benefits of having a Roth IRA retirement, but also some ways that you can help maximize those benefits and use that account to your advantage. So, you have questions on this, feel free to shoot me an email. It should be listed down below.

Jacob: 20:58

Also, if you're looking for help on how to manage your retirement or help plan for it, I'd be happy to have a conversation with you and share how I might be able to help. You can shoot me an email or schedule an intro call using the link down in the description below. Thanks so much, and we will see you next extend a quick offer to you. If you have a question and you would like to have it answered here on the show, please email me at jacobretirementanswers dot net. And I'd love to answer that question for you right here on the show.

Jacob: 21:28

Also, I wanted to remind you that nothing discussed in today's episode is meant to be financial, legal, or tax advice. Retirement Answers is for educational purposes only. Thanks for tuning into this week's episode. I look forward to talking with you again next week.