Upticks: Roth IRAs with Jake Cross

By Jake Falcon on March 10, 2022

Jake Cross, a member of the Financial Planning Group at Falcon Wealth Advisors, recently joined Jake on Upticks to discuss Roth IRAs, which are relatively new to the financial planning arena. Despite what you may have heard, they can be useful for both young and older people, as well as wealthy people or people who want to build wealth.

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Jake Cross, a member of our Financial Planning Group at Falcon Wealth Advisors, recently joined me on Upticks to discuss Roth IRAs, which are relatively new to the financial planning arena. Despite what you may have heard, they can be useful for both young and older people, as well as wealthy people or people who want to build wealth. A summary of my conversation with Jake is below.

Falcon: Jake, can you please share a brief history and overview of the Roth IRA?

Cross: Sure.In 1997, Congress passed the Taxpayer Relief Act, which created the Roth IRA. It is named after the late US Sen. William Roth.

Falcon: Many of our clients who are older didn’t contribute to a Roth IRA in their working years because it was so new and they were already contributing to pretax retirement accounts. Can you talk about some of the rules surrounding a Roth IRA?

Cross: I love the Roth IRA because it allows for earnings on your contributions to grow tax free, but its rules can be confusing. You have to have earned income from active employment (not income from Social Security, retirement distributions, etc.) to contribute to a Roth IRA. And annual contributions to a Roth IRA are topped out at $6,000 if you’re younger than age 50 and $7,000 if you’re 50 or older. It’s worth noting you can make 2021 contributions to a Roth IRA up until April 18, 2022 or when taxes are due.

All money contributed to a Roth IRA is from income that has already been taxed and you cannot access earnings from your contributions without penalty until age 59.5, certain exceptions apply. However, you can withdraw the money you’ve invested in the Roth IRA at any time—just not its earnings. I recommend keeping track of your tax returns, so in case you ever do need to withdraw from a Roth, you will know how much you invested.

Another important thing to know about Roth IRAs: there are income limits. For a taxpayer filing as single, there is a phase-out that begins when their adjusted gross income reaches a threshold of $125,000—though they can make some contributions up to $140,000 (for 2021). If you make more than that amount, you cannot contribute to a Roth IRA. For married couples filing jointly, the income threshold range is $198,000–$208,000 (for 2021).

Falcon: Are there any other rules to know about?

Cross: Yes, another important rule is the “5-Year Rule.” You have to wait five years from the year of your first contribution before you can withdraw any earnings. Even if you’re older than 59.5, if you break the 5-Year Rule, you have to pay taxes on the earnings.

Falcon: Let’s circle back and further discuss what makes Roth IRAs such an advantageous investment vehicle. As you mentioned, earnings on Roth contributions aren’t taxed. This means that if you invest $10,000 in a Roth IRA and when you retire it’s worth $100,000, you could withdraw that full $100,000 without having to pay any taxes on it.

A million dollars in a pretax IRA is not worth a million dollars, because you have to pay taxes on it. But a million dollars in a Roth IRA really is a million dollars. As you can hopefully see, a Roth IRA can be a game changer in a financial plan.

Cross: Required minimum distributions (RMDs) are another reason to consider investing in a Roth IRA. If you have money in a traditional IRA, the IRS requires you to begin taking RMDs from it beginning at age 72. The more money you have in a traditional IRA, the higher the RMD. And these distributions can force you into a higher tax bracket than where you want to be. There are no RMDs associated with a Roth IRA because you have already paid taxes on your contributions.

Falcon: Let’s now talk about who should use Roth IRAs.

Cross: Every situation is different, but generally speaking, younger people in lower tax brackets should consider a Roth IRA. You can pay taxes on the contributions now, let them and the earnings grow tax free, and then not have to pay taxes on withdrawals if you’re in a higher tax bracket years down the road.

Falcon: Of course, one variable is we don’t know what the US tax code will look like decades from now. But most analysts believe taxes will likely go up in the years to come, so it may make sense to go ahead and pay the taxes today.

Is there anyone who shouldn’t consider a Roth IRA?

Cross: Perhaps an older worker who is in their high earning years. They may benefit from taking advantage of a retirement account funded with pretax dollars. And if this person doesn’t expect to be impacted by RMDs, that’s another reason to choose a pretax account.

Falcon: Yes, it depends on how your assets are currently allocated. If you’re in your 50s and already have a lot of money in after-tax or Roth IRA accounts, it may make sense to focus on pretax accounts.

Cross: What’s nice about financial planning is we can revisit a decision every year or multiple times a year. Some people may go back and forth between Roth and pretax accounts based on their tax situation and other considerations.

Falcon:  We’ve briefly mentioned this, but some 401(k) plans now include a Roth feature, correct? I know limitations around a Roth 401(k) are not as strict.

Cross: That’s correct. There’s no income threshold to prevent contributions to a Roth 401(k). If someone makes $500,000 a year—and their company’s 401(k) plan includes a Roth—they can contribute up to the same limit they could in a pretax 401(k) account, which this year (2022) is $20,500 for workers under age 50.

Falcon: Yes, and as we mentioned, you can only make $6,000 worth of contributions to a Roth IRA. So the opportunity to contribute $20,500 (or more if you’re over age 50) is a good opportunity.

It’s worth noting that if your company matches your retirement contributions, they will likely go into a pretax account regardless of if your contributions are going in Roth or pretax.

Let’s now talk about Backdoor Roth IRA contributions, which have been in the news. What’s a Backdoor Roth IRA?

Cross: It’s a way to make a non-deductible IRA contribution to a traditional IRA and then convert those funds to a Roth IRA. It’s a strategy for people who are over the Roth IRA income threshold to contribute. The strategy of contributing to a Backdoor Roth IRA has served many of our clients well, but as you alluded to, lawmakers in Washington are discussing changing the rules to not allow for Backdoor Roth IRA contributions.

Falcon: It’s worth noting that Backdoor Roth IRA contributions are complex, especially if you already have a traditional IRA. It’s important to work with a fiduciary wealth advisor and your CPA if you want to explore a Backdoor Roth IRA—and the time for discussions is now, with the possibility that the Backdoor Roth IRA may not be available in the coming years.

Let’s also talk about Roth conversions. What’s that?

Cross: It involves taking your pretax assets—like money in a traditional IRA—and converting them into Roth IRA contributions. There’s no income limits around conversions and you can convert as much money as you want as often as you want. But this conversion is a taxable event, so the amount you convert will be taxable income.

For someone who’s retired and in a lower tax bracket than when they were working, it may make sense to convert as much money into a Roth IRA as possible, up until the point of being pushed into a higher tax bracket. This will allow you all the benefits of a Roth IRA and will lower the potential impact of RMDs.

Falcon: It also lowers the tax burden on your beneficiaries.

Cross: Yes, a Roth can be an important estate planning tool. It basically allows you to pay taxes on the money your beneficiaries will inherit, so they don’t have to.

Falcon: And it’s worth noting our team at Falcon Wealth Advisors has tax planning software that can analyze your recent tax return and offer suggestions for exactly how much someone should convert into a Roth IRA to take full advantage. Not all wealth advisors have the software we do and take tax planning as seriously as we do.

Roth IRAs are not as simple as people think but they are also more powerful than people realize. And they’re not just for young people. Whether anyone should use a Roth boils down to their goals and their current financial plan.

Cross: And while they can be effective, as we mentioned, they’re not for everyone.

Falcon: And for some people, especially if they’re a business owner or someone whose income or career is volatile, it may make sense to simply invest in a post-tax brokerage account so that you can access your money at any time, without penalty.

We love Roth IRAs for the right people and we discuss Roths in most all our client meetings.

Cross: Yes, and clients can share their 2021 tax returns with us and we can use our software to determine if and how they can benefit from Roth contributions.

Falcon: As I mentioned, the rules around a Roth can be complex. Please consider working with a fiduciary wealth advisor, especially if you want to pursue Backdoor Roth contributions or Roth conversions. Falcon Wealth Advisors prides itself on helping clients get into the most tax advantageous situation possible, and if you want to learn more about our wealth advisory and tax planning capabilities, contact me directly at Jake@falconwealthadvisors.com.

Clients choose to work with us to enhance their financial literacy and explain exactly what their financial plan means to them.