Roth IRAs: What to know

Roth IRAs. You've got questions. We've got answers. Roth IRAs do have income limits. What if I'm someone who makes too much money. Am I out of the game on this one? Good news. You're not. Can I have both a traditional IRA and a Roth IRA? This is really something you need to pay attention to. Tell me the catch. There are some caveats. Roth IRAs for kids. Well, this is actually one of the great features of a Roth IRA. [MUSIC PLAYING] Roth IRAs. From our teenage years straight through retirement there is a lot to know. Welcome to Money Unscripted. Here we're having candid conversations about life and money, judgment and jargon free. I'm Ally Donnelly. So today, we're going to dig into exactly what is this type of individual retirement account? What are the potential benefits? Who's eligible and when? And of course, how you could start saving. My guest is Rita Assaf, Vice President of Retirement Products here at Fidelity. And she's going to answer all of our questions. Fair Warning, Rita, I have a lot. Welcome. Thanks for having me. And I'm game. Awesome. All right. Let's start with the basics. What is a Roth IRA and how is it different from, say, a traditional IRA or a 401(k)? Great questions. Well, Roth IRA is an individual retirement account where you contribute after tax dollars. And your investment earnings and your withdrawals could be potentially, tax free, federally. So when you look at whether 401(k), traditional 401(k) traditional IRA or a Roth, you're really looking at the tax and how it's being treated. So with a traditional 401(k), the money is put in pre-tax. With a traditional IRA, it could be tax deductible. You put the money in after tax and you might be able to take a tax deduction. And with Roth, whether it's a Roth 401(k) or a Roth IRA, the money is after tax. So who is a Roth IRA typically good for? Well, Roth IRAs do have income limits to be eligible to contribute to it. And so what we see are usually younger people. They are still early in their career, have not met their peak wage potential. And so they fit usually within those income limits and can contribute and at a younger age. And if you can, it's really great if you could contribute because you have that much longer for those savings to grow. So younger in their career typically, is going to mean they're making less, so less to be taxed. Correct. OK. How much can you contribute in a year? And you also mentioned income limits. Map that out for me a bit. Well, the max contribution in 2024 to any IRA is $7,000. But with a Roth IRA, your income can dictate how much you can contribute. So let me break this down. So single individuals who are filing their taxes, if they're making $146,000 a year or less, can contribute the max. But let's say you're making between $146,000 and $161,000. You can contribute partially. And for married couples who file taxes jointly and earn up to $230,000, they actually can fully fund a Roth IRA. But they can also do a partial contribution if they make between $230,000 but less than $240,000. So you said $7,000. But if you're older, that's a little different, right? Yeah. So at age 50, you can actually-- Gasp. I said 50 is older, but you know what I mean. 50 is the new 30. Exactly. But in the eyes of the IRS, at age 50, you can actually make what we call a catch up contribution, which is $1,000 more that you can contribute. So for some people, they can actually contribute a total of $8,000 if they're 50 and older and they meet that income requirement. What if you're making less than 7,000 or 8,000 in a year? Well, your income will then determine how much you can contribute. So if you had earned income of $5,000, that's the max that you can contribute to that Roth IRA. So you can only contribute up to as much as you make? Correct. OK. I know that we get a lot of questions about Roth IRAs for kids. What are they? Who can start them? Give me all the dirt there. As a mom of like a working teenager, I need this information. Oh, of course. Well, not many people know about a Roth for kids. So Roth for kids. or you might see it referred to as a custodial Roth, is a Roth IRA where a custodian, so tha means an adult, can manage a Roth IRA for the benefit of a minor. And it works exactly the same way as any other Roth IRA, It's just that you're managing it for somebody else, in this case a minor. And you can contribute up to the max. The earned income also applies, as well, here. So when you say earned income, I'm thinking my daughter is going to have a job at the rec center this summer, like that kind of thing? Yes. And that's a great way to save. So if she earned $2,000, say, from that summer job, that's the most that she can contribute. But here's the benefit. It's that long term savings that will compound and you can take advantage of. So most of us, when we start saving for retirement, it's usually after we start our first job, we might have 30 to 40 years. But a teenager or a child could have 50 years or more. And so you're really taking advantage of that longer time horizon. Does the adult opening the Roth have to be a parent or guardian? No, as long as it's an adult. And as long as it's for the benefit of a minor. In this case, it's defined as anyone under age 18. So that's opening. What about contributing? Could I get a grandparent or an aunt and uncle or a favorite colleague? I don't know what you're telling me. My child's Roth. You can. But again, it's up to the earned income. So any adults can put money in. And actually a really great feature of a Roth IRA is that you can, as the adults, match the child's contribution. So for your daughter, if she made $2,000, she can contribute $2,000. But one great feature is that maybe she contributes $1,000 and then you or another adult matches her contribution at $1,000. As long as it doesn't go over the $2,000, you're fine. And this is really replicating that sort of 401(k) employer match. Right. So the $2,000 you're using the number $2,000 as a hypothetical because that's what she might make in a summer. But if she wants to have some cash for mad money and makeup, like I can put up that additional $1,000. But it can't go over what she made that summer. That's right. Or that year. Yeah. OK, great. So what happens when she turns legal age? What happens to that custodial feature? So each state sort of defines where the accounts open, defines the age at which the account should be turned over to the former minor. It's usually between 18 and 26. And what will happen is that the former minor, now an adult, will open a Roth IRA in their own name, and then the custodian will transfer the money and the assets into that new Roth for the former beneficiary. So now I'm the child. I'm an adult child now. So what if I don't convert it right away? The money stays as is. It's just it is restricted. Meaning you wouldn't be able to put in more. Trading, withdrawals are probably limited, as well, but you don't lose it. It's still there. It's just it's in restricted status. OK. Still my money, but not working as hard as it could. OK. So I was reading about a new option in 2024, about 529 accounts. The education accounts. What's the skinny there at this point? Yeah. This is a secured 2.0 provision. So SECURE 2.0 came out last year. And this is a really great feature for someone who has unused funds in a 529. Normally, there was no option to move that money without being penalized. And so what this feature does is that it allows you to transfer 529 money into a Roth IRA for the beneficiary of that 529. But there are some caveats, so you do want to pay attention. So here are a few. One, is that there is a lifetime limit of how much you can move. That's $35,000. The max that you can move each year is subject to the Roth IRA contribution limit, which for this year is $7,000. And to be eligible to even do this, you need to make sure that your 529 has been opened for that beneficiary for 15 years. And the money that you move over from the 529 cannot be from any contributions over the last five years. So two things. So first of all, I can't believe anybody ever has any money left over in their 529 looking at the cost of college right now. But I can imagine if you-- I have a friend whose nephew didn't go to college decided but they had already saved. Or maybe they got a grant or a big scholarship or something like that. So secondly, I want to dig into that 15 years. So is all hope lost if I only recently opened a 529 for my child and it'll only be six years after when if there's any money left over? No, but you do have to wait for that 15 years to be open to be able to move that money over. But it does not hurt you to wait until that time. OK. I don't lose it. It's just kind of parked and I can't use it. OK. When can I start taking withdrawals from a Roth IRA? Well, this is actually one of the great features of a Roth IRA, is that flexibility in withdrawals. So many people are fearful of retirement accounts because their money is locked up. But with a Roth IRA, there are some actually flexibility. So I'll just say this. Any contributions that you put in, your contributions can be withdrawn at any time penalty and tax free. Just the contributions. Correct. OK. And then from there, what the IRS says is once your contributions, you've taken out all of your contributions, it'll start to take out money from any conversions that you might have made, provided that each conversion has met a five year aging period. And from there, if you've withdrawn all of that, then you can actually withdraw from your earnings. However, this is where there could be tax or a potential penalty unless it's qualified. What does qualified mean? Well, qualified means that you've sort of hit an exception, and the exception list can vary. But some popular ones are that you've had the account for five years and you're either 59.5 or you're a first time home buyer. Those are just some of the options there. But you would want to check those, because you don't want to inadvertently be hit with a penalty. So that you can check those options both on Fidelity.com as well as on the IRS website. And you mentioned conversions. So let's get to that. Some people might look at that and say oh, awesome, I want to do that, but I make too much money. So I know I've heard you talk about backdoor Roths, but I really need you to map that out for me. Sure. And this is a complex topic. It's a tricky one. And I definitely would urge anyone considering any Roth conversion, to definitely talk to a tax advisor and a financial advisor, but specific to a backdoor Roth because that comes up a lot. So this is where someone who makes too much would contribute what we say is non-tax deductible money into a traditional IRA. And what that means is they make too much income wise to that they can't even take a tax deduction in their traditional IRA. So they move that money immediately from the traditional IRA to a Roth IRA. And now you've done a backdoor Roth. And it's called a backdoor because you can't go through the front door, which is contributing to a Roth directly. That sounds like that's a good idea. But there's got to be-- tell me the catch. Well, that is just one option of a Roth, a backdoor Roth conversion. There are other Roth conversions. So another type is that you actually have tax deductible contributions you can make to a traditional IRA, which you do, and then you move it to a Roth IRA. That's a Roth conversion. But you do have some taxable income that you have to pay. Likewise, we've seen people who move, who do a Roth conversion from their 401(k). They take money that was in a pre-tax traditional 401(k) and convert it to a Roth IRA. But with that feature, you really want to look at your workplace plan rules, because not everyone is eligible to do that while they're working. And there is tax implications here that could be a larger tax implication. And you don't want to make a tax mistake. Even though this is great in converting could be beneficial for you, you just want to be careful. And we should say we're not tax professionals. Everybody's situation is different. You should seek out the help of a tax professional for your particular situation. And we were talking earlier off camera and you had told me about the calculator. What's that? Yeah, so we have an IRA contribution calculator. And what it does is it allows you to see whether-- how much you can contribute, whether it's to a traditional IRA, Roth IRA or both. And it determines that from a few questions that we ask, including your income limits. So it's a great tool and feature that we have that if you want to check it out it is on Fidelity.com/iracalculator. Great. That was a lot of information though. So run through, if you would, pros and cons of a backdoor Roth. Yeah. So one of the pros is that it allows you to move money to a Roth that you've been ineligible for. Your withdrawals could be tax free in retirement. And you don't have those required minimum distributions or RMDs refer to it. Tax free from federal income. Correct. OK. And the cons are really that there is a tax impact potentially, so it's an advanced strategy. You do want to talk to a tax advisor. And second, by doing a Roth conversion and a backdoor Roth, it can put you in a higher tax bracket. So it's just something to consider. Yeah. OK. So I hear a lot about RMDs. What are they and how does it apply here? Well, RMDS, which are required minimum distributions come into play once you reach a certain age. Right now it's age 73 and up. And it usually means that you have to take a distribution from your pre-tax or tax deductible retirement accounts. So what I mean there is a traditional IRA, as well as a 401(k), a pre-tax 401(k). But with these, there aren't any, right? That's right. So Roth IRA does not have RMDs. And new this year, Roth 401(k)s actually do not have RMDs, as well. Yeah. OK. How about in retirement? Here I am. I want to maximize my Roth benefits. How do I do that? Well, so any IRA, when you contribute money, you do have to take that extra step to invest. And many people don't realize that because in a workplace plan they're generally auto invested. So you do want to make sure you're taking that extra step to make sure it's working for you. But that's not just in retirement. That's all the time, right? Correct. Yeah, just any IRA. Whenever you put in savings, you just want to make sure that you're investing. Right. So it's a vehicle to investing. It's not investing itself. I get it. OK. To that end, can I have both a traditional IRA and a Roth IRA? You can. And this could be a great idea. I mean, it could vary depending on your income limits. So you may not be eligible for both, but if you can, it's a great tool, because you're making use of what we call tax diversification. And this comes in really when you're in retirement and you're trying to manage that you have to take out money now from these retirement accounts. And you're trying to see, well, what tax will I owe? So if you have both, you're basically making use of tax deductible potential money in a traditional IRA, which once you take that out in retirement, you do generally have to take pay taxes. And then Roth IRAs, which generally, retirement, you do not have to pay any taxes. So it can help manage your tax bracket in retirement. How do I figure that out? You can use our calculator. And it's always helpful to talk to a financial advisor, as well, because you want to make sure that you have a great retirement income plan that can actually solve for these different things. Because that is a concern in retirement that we see, even today, with retirees. You know, how do I manage my tax bracket in retirement? You know, you do so much to save that you don't realize then, well, I'm retired now. Why am I in a higher tax bracket? And it really does come down to distributions that you're taking out of these retirement accounts. OK. One thing we haven't talked about is a Roth 401(k). What is it? Well, a Roth 401(k) is sort of a hybrid of what we call Roth and a 401(k). And what it means is it's a 401(k), you're just putting in after tax money to it. But here's one of the benefits. Because it's a 401(k), you have higher contribution limits, which for 2024 is $23,000. But there are some differences. So with a Roth 401(k), there are some rules when withdrawing from a 401(k) that you want to check out. And secondly, another, this is actually a benefit of a Roth 401(k), starting this year, there are no required minimum distributions. What about income limits? Income limits do not apply to a Roth 401(k) so that's actually another key benefit for contributing after tax. Obviously, I'm not steeped in all of this like you are. But I feel like I haven't heard as much about Roth 401(k)s, or at least until recently. So are people taking advantage of it? Well, it's growing, but still small. So from our own Fidelity data of our workplace plans, about 78% of our plans offer it, but only 14% of participants take advantage of it. Some of it is an awareness, you know, they just don't realize that they have a Roth 401(k) option. Or they're just confused as they try to figure out, how much do I put in for my regular 401(k) versus my Roth? However, starting in 2026-- and this is a SECURE 2.0 provision which will be helpful-- after you turn age 50 and you make more than $145,000 from the prior year, all of your catch up contributions now have to be made on an after tax basis. And what that means is that most workplace plans now will have to make a Roth option available. What about the tax deferral issue? The tax deferral is still there. That's a great benefit. It's just that now any catch up contributions over that certain income limit is after tax. You've talked about earned income a lot being a requirement for a Roth IRA. What if I'm married but I'm not working. So I'm not earning income? Well, there's a great feature that we call or refer to as a spousal IRA, and that's not a new type of IRA. It's still a traditional IRA, Roth IRA, but it allows a spouse, if that spouse is filing taxes jointly with their married partner, to contribute to an IRA of their own. And the income limits will be based on the working spouse's income. So as I look at my accounts, can I have both an IRA and a Roth? You can, if you meet the eligibility requirements, which are usually income related. But here's an important piece, which is your total contribution to both accounts is still $7,000. It's not $7,000 to each account. It's an aggregate. If I'm under 50. Yes. OK, great. What if I pass away? What happens to my Roth IRA? Well, the money will move to beneficiaries, just like any other money that you might have upon death. However, one key call out is that inherited Roth IRAs do have required minimum distributions. But the benefit here is that the withdrawals are federally tax free. So that is one benefit. And there are a few other exceptions. So that should be considered as part of a holistic estate plan. OK. Let's do a highlight reel. Quick recap on the positives, the benefits of a Roth. The flexibility. So your contributions can be taken out at any time, tax or penalty free. For any reason? Correct. And for any investment earnings and withdrawals, they could also potentially be tax free if certain conditions are met. This has been such a valuable conversation, Rita. Thank you. Thank you for having me. Thanks to all of you for being here. And if you want more life and money conversations, head to our website. It's Fidelity.com/MoneyUnscripted. Because after all, it's your life. Get your money's worth. [MUSIC PLAYING]