Your Guide to Roth IRAs

Over the last few years, there’s been a lot of ‘buzz’ in the media about Roth IRAs. But are they right for you?

In today’s post, we’ll help address both of these questions to help you understand the pros/cons of Roth IRAs so you can evaluate if they make sense for your situation.

Introduction to Roth IRAs: 

A Roth Individual Retirement Account (IRA) is a powerful financial tool that offers unique advantages for retirement savings. Unlike Traditional IRAs, contributions to a Roth IRA are made with after-tax dollars, meaning withdrawals in retirement (after age 59.5) are generally tax-free.

1. Eligibility: 

Not everyone is eligible to contribute to a Roth IRA. To make full contributions, you need to have earned income, and your modified adjusted gross income (MAGI) must be below certain limits. Here’s a guide to reference the 2024 MAGI limits for Roth IRA contributions. These limits vary based on your filing status, especially if you’re Married Filing Separately (Roth IRA phaseout for MFS is only $10,000 of MAGI).

NOTE: Some individuals who are over the MAGI threshold may be able to use a financial planning technique called the Backdoor Roth IRA strategy. We will cover this in a later newsletter, but if it’s something you’re interested in, you should reach out to a qualified financial professional to see if it makes sense for you. I’m also available if you have questions at caleb@advancedpracticeplanning.com.

2. Contributions: 

As of 2024, the maximum Roth IRA contribution is $7,000 (or $8,000 if you're 50 or older) annually. 

Contributions can be made at any age, as long as you have earned income. It’s important to note however, that you can only contribute to a Roth IRA to the extent that you have earned income. So, if your only earned income for the year is $5,000, then you can only contribute $5,000 to a Roth IRA, not the full $7,000 amount.

The IRS typically increases the MAGI and contribution limits increase each year by a slight amount, but it’s not guaranteed that they’ll do it every year. That’s why it’s important to check these limits before contributing to your Roth IRA each year. You can find more info on the IRS website. 

3. Tax Advantages: 

One of the primary benefits of a Roth IRA is tax-free withdrawals in retirement. Since contributions are made with after-tax dollars, you generally won't owe taxes on qualified withdrawals. This can be especially advantageous if you anticipate being in a higher tax bracket during retirement.

I like to use the analogy of a farmer paying tax on the seed he plants rather than the harvest that he receives at the end of the growing season. 

4. Investment Options: 

Roth IRAs are individual retirement accounts that you can elect to manage on your own or with the help of a financial planner. Roth IRAs generally offer a lot of flexibility with respect to the investments you can purchase inside your account. Investopedia has a great list outlining the investments you can/can’t purchase inside a Roth IRA account.

5. Withdrawals: 

While contributions can be withdrawn at any time tax and penalty-free, there are specific rules for withdrawing earnings. To qualify for tax-free withdrawals on earnings, generally the account must be open for at least five years, and you must be age 59½ or meet other qualifying conditions (first-time home purchase, disability, etc.).

6. Roth IRA Conversions: 

If you’re over the income threshold to contribute to a Roth IRA and the Backdoor Roth IRA strategy doesn’t make sense for you, you still may be able to get funds into a Roth IRA by doing a Roth Conversion. 

Roth conversions are different than contributions. As of 2024, there are no income limitations on Roth Conversions. 

A Roth IRA conversion consists of taking pre-tax retirement assets and converting them into Roth IRA dollars. 

So if you’re in the 22% Federal Income Tax Bracket, and you convert $50,000 of pre-tax funds into your Roth IRA, you would pay approximately $11,000 in federal income tax but the funds would then be able to grow tax-free in your Roth IRA moving forward.

This strategy doesn’t allow you to contribute ‘new’ money to a Roth IRA per se, since you’re converting pre-tax funds you already contributed at some point throughout your working career, but it can be a valuable planning technique to lower your overall lifetime tax liability.

As you can see, there are a lot of factors that go into determining if a Roth IRA conversion is right for you. Before processing a conversion, you should talk to your accountant and/or financial planner to see if it makes sense for you.

Wrap-Up

Roth IRAs are a great way to save tax-efficiently for retirement, but aren't always right for everyone. Understanding the eligibility criteria, contribution limits, and the tax advantages can help you make informed decisions about incorporating a Roth IRA into your overall retirement strategy. 

Thinking About Retirement?

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About The Author

Caleb Pepperday, CFP®, ChFC® provides Fee-Only Financial Planning and Investment Management Services for medical professionals. Advanced Practice Planning, LLC is based in Missoula, MT, but works with clients in a virtual capacity nationwide.

As a CERTIFIED FINANCIAL PLANNER™ and fiduciary, Caleb Pepperday works to create financial plans for medical professionals with their best interest in mind. As a Fee-Only financial planner, Caleb Pepperday is only compensated through the investment management or financial planning fees that you pay him directly and never earns a commission.

Caleb Pepperday primarily focuses on helping mid-career and pre-retiree Physician Assistants/Physician Associates retire with confidence.

Disclosures:

The information provided in this article is for educational purposes only and is not intended as financial, legal, or tax advice. No content within should be construed as such. The material presented is based on general financial principles and concepts, and individual financial and tax situations may vary. Readers are strongly encouraged to consult with a qualified financial advisor, tax professional, or legal expert for personalized advice regarding their specific financial, tax, or legal circumstances. Any actions taken based on the information in this article are at the reader’s own discretion and risk. The author and publisher make no representations or warranties regarding the accuracy, applicability, or completeness of the information provided. This article does not endorse or promote any specific financial products, services, or companies. Readers are responsible for conducting their own research and due diligence before making any financial, legal, or tax-related decisions.