Taken From A Conversation With Howard Jackson

Recent media reports about individuals accumulating mass wealth in Roth IRAs have piqued interest in Roth IRAs, and consumers want to know how they can get in on the Roth game. This includes my friend, Howard Jackson, an Information Technology Manager who lives in Winter Garden, Florida. Howard\’s Roth IRA questions range from the basic to the complex and I hope they help you make a decision that is right for you.

Businesspeople explaining and listening at meeting


Howard Jackson: What is the maximum amount I can contribute to my Roth IRA as a regular contribution?

Response: It depends. Roth IRA contributions are capped at $6,000, or $7,000 if you are at least age 50 by the end of the year. However, the following two factors also determine how much you may contribute to your Roth IRA:

1.  You must receive eligible compensation for the year. Eligible compensation includes wages, tips, self-employment income, and commissions. Your Roth IRA contribution cannot exceed the lesser of $6,000 ($7,000 if you are least age 50 by the end of the year) or 100% of your eligible compensation.

2.  Depending on your tax filing status, your modified adjusted gross income (MAGI) must be below certain amounts.

The following are the MAGI limits for 2021 and 2022

MAGI limit for Roth IRA Contribution eligibility for 2021 and 2022

Denise Appleby

If your MAGI falls within the \’partial percentage\’ range, your tax tax-preparation software will calculate your allowed contribution amount.

Howard Jackson: Can I make regular contributions to both a traditional IRA and a Roth IRA the same year?

Response: Yes. Your total contributions to both cannot exceed the lesser of:

(a) 100% of your eligible compensation, or

(b) $6,000 ($7,000 if you are at least age 50 by the end of the year).

A common strategy is to split regular contributions between traditional IRAs and Roth IRAs to benefit from both types of IRAs. This split strategy is also often used by individuals whose MAGI falls within the partial range (see above). For example, someone eligible to contribute only $2,000 to a Roth IRA might contribute $2,000 to their Roth IRA and $4,000 to their traditional IRA- making the total contribution for the year $6,000.

Howard Jackson: If I contribute more to my Roth IRA than my annual income permits in a particular year, what are the implications of that and what should I do?

Response: In that case, you would have an excess Roth IRA contribution and must correct it to avoid excise tax on the amount. Excess contributions that are not corrected by your tax filing due date, plus extensions, are subject to a 6% excise tax for every year they remain in your Roth IRA. The correction requires that you distribute the excess amount along with any net income attributable (NIA) to the excess contribution. The NIA can be earnings or losses. If your IRA custodian does not calculate the NIA, your tax advisor may use the instructions provided by the IRS, available here

Howard Jackson: Why would I want to convert my traditional IRA to a Roth IRA? Does it make sense all the time or only in specific situations?

Response: Generally, the goal of converting amounts from a traditional IRA to a Roth IRA is to minimize the amount of income tax that would be owed on those amounts. Whether it makes sense for you is determined by your Roth vs Traditional IRA profile. Your Roth vs Traditional IRA profile is created from a Roth suitability assessment. This assessment takes several factors into consideration, including the following:

  • The tax treatment of earnings: Growth on investments in your traditional IRA are taxable at your ordinary tax rate when you take distributions of those amounts. For Roth IRAs, growth on your investments would be tax-free when Roth IRA distributions are qualified. An example of a qualified distribution from your Roth IRA is a distribution that is made when you are at least age 59 ½ and have funded a Roth IRA for at least five years.
  • Your current income tax rate vs. your projected income tax rate at the time you are projected to take distributions: Generally, if your tax rate would be lower now than when you plan to take distributions, it is considered more tax-efficient to convert your traditional IRA to your Roth IRA now as the conversion would be taxed at your current (and lower) rate. If the amount is not converted, it would be taxed at your higher tax rate when you start taking distributions. If your tax rate is projected to be lower during your distribution years, converting now might cause you to pay more income tax on that amount.
  • The source of the funds used to pay any income tax due: A conversion from your traditional IRA to your Roth IRA would be treated as ordinary income, with any pre-tax amount taxed at your ordinary income tax rate. You might need to take distributions from your IRA to pay any income tax owed on the conversion if you do not have funds outside your IRA to cover the amount. That IRA distribution would not be included in the amount credited to your Roth IRA and would be subject to a 10% early distribution penalty if you are under age 59 ½ at the time of the distribution.
  • There are no mandatory distributions for Roth IRA owners: You must start taking required minimum distributions (RMD) from your traditional IRA for the year you reach age 72 and continue for every year after. Roth IRA owners are not subject to this RMD requirement, allowing the amount to continue to benefit from tax-deferred (potentially tax-free) growth longer.
  • Who/What is your beneficiary? If your beneficiary is a charity that will not owe income tax on IRAs it inherits, it usually makes better tax sense to leave your traditional IRA to the charity. On the other hand, if your children, spouse or other tax paying individual will inherit your IRA, consideration might be given to whether it is more tax savvy for you to pay the income tax that would be owed on the amount and leave them a tax-free Roth IRA, or leave them your traditional IRA and have them pay any income tax due.

These explanations are high-level, and not all factors are listed. Ideally, it would be best if you worked with your tax advisor to have a Roth IRA suitability assessment done.

Howard Jackson: My company recently started offering a Roth 401(k) along with the regular 401(k) that has always been available. How is that different from a Roth IRA?

Response: The differences between and Roth IRA and a Roth 401(k) include the following:

High level summary of differences between a Roth IRA and a Roth 401(k)

Denise Appleby

Other differences vary among 401(k) plans and often include available options and opportunities for investments and estate planning.

The good news is that you can fund both, as funding one has no effect on your eligibility to fund the other.

Howard Jackson: If I leave my job, can I roll over my Roth 401(k) to my Roth IRA with no tax consequences due to the rollover?

Response: Yes. Because you would be making the rollover from one Roth to another, it would not be taxable. However, any amount attributed to earnings would be taxable when distributed from your Roth IRA if it is not part of a qualified distribution (see above).

Howard Jackson: What type of assets other than stocks/bonds can I hold in a Roth IRA?

Response: You can hold any publicly traded asset in your Roth IRA.

You may also hold non-publicly traded assets, including closely held corporations, limited partnerships, real estate, and other property in your IRA. However, you must consult with your tax attorney before investing in these types of investments to ensure that it does not violate any restrictions set by the Internal Revenue Code (Tax Code). Violations could result in the disqualification of your Roth IRA.

Not all Roth IRA custodians offer all investments. Be sure to check with your Roth IRA custodian to determine which investments are available on their platform.

Howard Jackson: Can the beneficiary of my Roth IRA be different from the person(s) to whom I leave other assets in my will?

Response: Yes. Your will does not govern who is the beneficiary of your Roth IRA. The party you want to inherit your Roth IRA must be designated/named on the Roth IRA beneficiary form provided by your Roth IRA custodian. This party can be different from the beneficiaries named under your will.

Howard Jackson: Can an organization be the beneficiary of my Roth IRA?

Response: Yes. You may designate charities, corporations, and other entities as beneficiary of your Roth IRA.

My additional comments

Roth IRAs make an excellent addition to a retirement savings portfolio. Combined with traditional retirement savings accounts and non-tax deferred savings, they help provide tax diversification and opportunities for tax-efficient drawdown during decumulation years. Retirement planning is not a do-it-yourself project, and one of the steps towards maximum tax efficiency and suitability is working with an advisor who is proficient in this area during both the accumulation and decumulation phases.