Houston Bookkeepers Tip: Why High Income Clients Should Switch to a Roth IRA

Here at B&J Bookkeeping and Taxes, we love sharing tips on how to save money. However, we also love giving our clients tips on how to make money, especially in how they can make their money work for them. For those of you with a few dollars to put away for the future, it’s time to consider a Roth IRA.

1. What is a Roth IRA?

This is an individual retirement account (IRA) in which holders may make contributions into dollars that have already been taxed. This allows these contributions to grow without a tax, and holders can often make withdrawals from their Roth IRA without taxes or penalties once they reach the age of 59.5.

2. Roth IRA vs. Traditional IRA

A traditional IRA works in almost the opposite fashion. Funds may be contributed to the account before taxes have been paid on them up to a certain amount, which has its pros and cons depending on your financial goals. One major downside is that earnings may not always be tax free and the age requirements to withdraw are usually higher.

3. Converting to a Roth IRA

If you’ve decided a Roth IRA is the way to go, why not convert your traditional IRA into one? It’s not as easy as it sounds but can well be worth the effort under the right circumstances. Converting a traditional IRA into a Roth may come with a hefty tax bill for those with high incomes, but the decision has some great benefits worth considering. The conversion is beneficial for those who expect their income to rise in the coming years or if they anticipate a future tax hike – which in our experience is usually the case. By paying into a Roth IRA at a lower tax rate, holders will save and gain more in the long term.

4. Downside to a Roth IRA

However, this is only advisable for those who plan to invest far more into their Roth IRA than it is worth now. This is because the total tax bill including state, federal, local, Medicare, and other taxes could amount to approximately 50% of the amount to be converted from traditional to Roth. However, those beginning a Roth IRA will not have to worry about this.

5. Upside to a Roth IRA

NO REQUIRED MINIMUM DISTRIBUTIONS

Other IRA accounts require holders to take a certain amount out of the account once they reach a certain age, a scenario that can be undesirable given the uncertainty of the future. This required minimum distribution is usually enforced in order for the IRS to collect the taxes that were never paid when the IRA began.

This means that holders of Roth IRAs can pass the funds on to their beneficiaries should the worst happen, while the beneficiaries of other IRAs would have to pay the tax owed.

For individuals who expect their income to be greater at the time of withdrawal than at the time of deposit, a Roth IRA also makes since given the tax will already be paid at the time of deposit. For individuals who expect the tax rates to rise, it also makes sense to pay it now when making contributions rather than when it is time to withdraw.

6. Other Things to Know About a Roth IRA

• There is no mandatory distribution age.
• Contributions to the IRA are not tax deductible.
• All principal and earnings are one hundred percent tax free if all rules and regulations are adhered to.
• Roth IRAs are available only to those who individually file and make up to $95,000 per year or those filing jointly who earn a combined income of up to $150,000 per year.
• Roth IRA funds can be used to acquire a variety of investments including bonds, stocks, certificates of deposits, and more.
• Subject to a few conditions, Roth IRA principal contributions may be withdrawn any time without paying a penalty.

Want to know what you could earn with a Roth IRA? Use this calculator from Bankrate to find out.