A quick detour to talk about taxes

From Retirement Now Newsletter 3-17-2022

“You have no idea of the *magnitude* of this thing! If she is allowed to infiltrate this world, then George Costanza as you know him, *ceases* to exist! You see, right now, I have Relationship George, but there is also Independent George. That’s the George you know, the George you grew up with – Movie George, Coffee Shop George, Liar George, Bawdy George… And he’s dying Jerry! If Relationship George walks through this door, he will kill Independent George! A George, divided against itself, *cannot* stand!”

-George Costanza from Seinfeld

Since April 15th is almost upon us, it’s a good time to take a break from the news cycle talking about war in Ukraine, and talk about something that’s a lot closer to home for most of us… taxes.

More specifically let’s discuss Roth IRA’s.

Putting money in a Roth IRA is a lot like your money’s “worlds” colliding.

And no, the result of these worlds colliding will not be as dire as George’s “worlds” colliding.

In fact, the result for you can be quite a good thing.

Money living in the “world” of being non-qualified gets taxed on its earnings every year. Think about a brokerage account you may have where you get a 1099 for the dividends you earned that year, or the capital gains you experienced.

When money goes into the Roth IRA world, the contributions have already been taxed. But the growth on those contributions will be tax free.

Which is why people will often use the Roth IRA as their most aggressive expected growth investments… because all the growth will be tax free.

But the money “worlds” collide in a certain way.

First there are rules surrounding how long money needs to be in a Roth IRA for its growth to be tax free when you pull it out.

These rules are not hard to follow.

You still have the 59 ½ age rule. If you pull out funds from the Roth IRA before that age (unless you have an exception) then the portion that is counted as “growth” is penalized 10%.

Your contributions are never subject to this 10% penalty, since they already had taxes paid on them when you put them in the Roth.

For many of my readers they are over 59 ½ and this rule doesn’t apply anyway.

So what they need to remember is you need to have your Roth IRA for 5 years before the growth portion can be pulled out tax free.

This is not hard to do. If you don’t already have one, you could literally open up a Roth IRA account with $100 just to get the 5 year clock ticking.

The Roth IRA is long-term funds anyway in most circumstances. They are your most coveted dollars because they earn you tax free growth, and they are tax-free when you withdrawal… even if Congress has raised taxes at some point in the future.

So different “worlds” have different rules when it comes to Roth IRA funds and regular ‘ol non-qualified funds.

But I think some of your dollars will really enjoy living in Roth world, where the temperature is always great and the sun is always shining.

But as for the here and now…

Perhaps the most important five things for you to know at this point is:

1 You have until April 18th to make a Roth contribution that counts for the 2021 tax year

2 You can put up to $6,000 into it, but if you’re 50+ you can put up to $7,000 in. (Note: you have to have earnings for the year to make a contribution.)

3 If your income exceeds $125k for single filers and $198k for married joint filers, a phaseout begins where you can’t contribute the full amounts listed in point number two above.

4 If your income exceeds $140k for single filers and $208k for married joint filers you can’t make any contributions.

5 Don’t worry, you can do Roth conversions, but for a Roth conversion to count for the 2021 tax year, it had to be completed before December 31st of 2021… so that’s too late. Any conversions you do this year will show up on your 2022 taxes.

A Roth conversion, or even a Roth contribution may not be the best thing for everyone. For example, if you’re in a very high tax bracket right now, any Roth conversions you do will be taxed at that higher tax rate. And any Roth IRA contributions you make would mean you sacrificed getting to make a deductible Traditional IRA contribution instead that would’ve saved you some money.

Also, if you’re already on Medicare, be sure to check that any Roth conversions you do won’t cause you to pay higher Part B and Part D premiums. Just one dollar of income over the limit can cause those premiums to be increased.

But there are a lot of good things about Roth IRA’s.

Mainly that when the “world’s” rules are followed they protect you from future tax rate increases that may come out of Congress.

Probably a pretty good idea to have some funds shielded from that threat.

Hope this helps you in planning for your awesome retirement.