Traditional vs Roth IRA

Welcome back to We're Talking Money Short Takes. We're gonna be talking about the difference between a Roth IRA and a traditional IRA, and what to do if you make too much money and you can't contribute. First thing we want to do, Phil, is we really want to just talk about what those different types of investment accounts are. Can you talk to us a little about the traditional IRA and how that works?

Most of you listening, you've heard of an individual retirement account, so IRA is a commonest household. Traditionally, the IRA just allows you to put money into this account. Whether you have a 401k, you can generally fund an IRA. You can put six to seven thousand a year in this thing, and when you do that, as long as you qualify for the deduction, you can tax deduct.

The maybe not so great part about the IRA is when it starts coming out, everything is taxed as ordinary income. But you do get the benefit of letting that money grow for as long as it sits in that account. So it's not a bad tool, and I think everybody should use them, especially if you don't have anything at work. It's better than nothing.

So when don't you get the deduction? If you put the money in, is there, are there limits? How does it...

Yeah, great question. So you could be phased out. You might miss the ability to deduct. So a lot of people put money in an IRA and they think automatically they get to deduct all of that, and usually you do. But if you have income that goes over a certain amount, so if you're married filing jointly, one spouse is in a 401k, you can make up to 214 000 per year and still contribute to a IRA and get the deduction. If you are married and both of you participate in the 401k, 129 is your limit, and then 78 000 for the single filers.

So you get to deduct, but only if you have certain levels of income, and when you exceed that level of income, that deduction begins to phase out. That's the bad part of the IRA. The other issue would be if you have a 401k at work, and if you have that and you're making all this money, you're in that 401k, that also would prevent you from deducting the IRA. You can still put money in that IRA no matter what. You just can't deduct the contribution.

So moving gears here, let's say that you're making too much money, or maybe you have access to the 401k, so you don't get the deduction. There's a plan A and a plan B. What are the other options?

And then the other one is the Roth IRA, and this is a tremendous accounting. You put the money in, you don't take a tax deduction. So right on the surface level you may say, well, I'd rather have a deduction than not have a deduction, why would I do this one over here? But the Roth IRA, no deduction, after-tax money, but it's going to grow tax free forever, and when you pull it out for retirement, we're tired, that's 100 tax free.

You are serious. Most likely for retirement you're going to have money in a 401k, gonna have money in an IRA. You're going to have this money that's going to be taxable when you pull it out, and if we can stack that with some tax-free income, now all of a sudden we can start to manipulate your tax bracket, and we can make your money last a heck of a lot longer.

With the Roth IRA, you can't put more than six or seven thousand dollars per year. Six thousand if you're under the age of fifty. Seven thousand, you get a thousand dollar catch up is what they call it. And there's also income limits on the Roth IRA as well. So once you make over 144 000 as a single taxpayer, your adjusted gross income that is, then you can't contribute. And then 214 000 married filing jointly, now all of a sudden you can't contribute.

Might be important for you to know, this is adjusted gross income. AGI, or adjusted gross income, doesn't necessarily mean what you earned. Adjusted gross is what they use to decide if you can contribute to a Roth, so know the difference. It could be that once your accountant starts working on your tax return, you might have that number below 144.

But if you're making over that 144 and there's no way that you're going to be able to have enough deductions to get it under the 144. My money, my problems. Lucky. What do you get to do then? Based on the way you're looking at me and raising your eyebrows, I suspect you're going to tell us about that little back door thing, right?

So essentially how the backdoor Roth IRA works, and we don't know if it's going to be around forever, but right now in the tax code there's no restriction from you putting money into an IRA. There's only the restriction of taking the deduction. So we can still put the money in the IRA, and then on the other side, there's no restriction of you converting money from an IRA to a Roth, regardless of how much money you make. The restriction is only you can't put money directly into the Roth.

We got growth tax free, distribution tax-free, and if you unfortunately passed away, you leave that money to your children, they don't pay tax either. Don't forget about this one, and if you didn't know about it, reach out to us. If you're interested in learning more, you want to use one of these things, we can show you how. And if you already have a lot of IRA money and you want to get that money into a Roth because you see the advantages here, and if these advantages make sense for you, then we can show you how to do that as well.

Until we see you next time, check us out on social media, check us out at omnistarfinancial.com. We're here to help. See you soon.

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