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The link to our FREE Roth IRA contribution flow chart is at the end of the article!
We remind our clients that having many options is better than having none and finding yourself in a corner. The Roth IRA is not your typical retirement account but an excellent addition to your retirement plan. It provides a great option in addition to your current 403(b) and 457(b).
As funding for retirement is a significant concern for many people, especially many of our clients who are educators, once you realize the benefits of a Roth IRA, you will like to get started with one quickly. Like any retirement fund, you want to start as early as possible because trying to catch up late is like arriving late to your party while your guests have already enjoyed the festivities.
What is a Roth IRA?
A Roth IRA is like a traditional IRA but has a couple of essential distinctions.
First, the similarities between a traditional IRA and a Roth IRA are:
As of 2024, you can make an annual contribution of $7,000 per year, or if your age is 50 or older, you can use the Catch-Up provision and contribute $8,000 per year.
You can begin taking withdrawals without being subject to an early withdrawal penalty of 10%, starting at the age of 59 ½.
You can open a traditional or Roth IRA at any brokerage firm and manage it yourself, or an investment professional can manage it for you.
Both allow you to add diversification to your overall retirement strategy. Both accounts allow access to various investments, such as alternatives or other assets unavailable in your 403(b) and 457(b).
The significant differences between traditional & Roth IRAs:
Contributions to a Roth IRA are, unfortunately, not tax-deductible.
Withdrawals from a Roth IRA are tax-free as long as you meet the following requirements:
You are at least 59 ½ years old.
The Roth IRA account is open for at least five years.
The Roth IRA is the only retirement account not subject to the required minimum distribution (RMD) requirement that retirement accounts have. The RMD requirement is an IRS requirement that states that you must start taking distributions from the account at age 73.
You may withdraw early and not be subject to income tax and/or a 10% early withdrawal penalty (more on this below).
Can you contribute to a Roth IRA?
The answer depends, but the Roth IRA most likely phases out after reaching certain income thresholds.
The income thresholds as of 2024 are:
If you are married and filing jointly, and your Modified Adjusted Gross Income (MAGI) is:
$240,000 or more – you cannot contribute to a Roth IRA.
$230,000 or more, but less than $240,000 – you may contribute partially to a Roth IRA.
Less than $230,000 – you can make a total contribution.
If you are single and your MAGI is:
$161,000 or more – you cannot contribute to a Roth IRA.
$146,000 or more, but less than $161,000 – you may contribute partially to a Roth IRA.
Less than $146,000 – you can make a total contribution.
Now that we have covered the definition and eligibility for a Roth IRA, here are the seven facts about why a Roth IRA is vital for an educator's overall retirement plan.
7 Facts About Why Roth IRAs Are Vital for an Educator's Retirement Plan
1. Create an Additional Savings Bucket for Early Retirement
As educators, you play a crucial role in developing society's future. It is a fulfilling profession. Perhaps you began as a teacher's aide, then a teacher, followed by a coordinator, and then made the big jump to an administrator (principal/vice-principal) or work in the school district office. Perhaps you took the route of being a professor and have publications with some residuals from your publications.
It is an arduous journey, and you don't want to do it for many years. However, the decisions you make now in your financial life are crucial to how you want to live your life in retirement. An educator's pension or retirement account and Social Security may not be enough to cut it during retirement. If you can learn anything from these last few years, the world throws unpredictable things: pandemics to high-flying inflation. High inflation is a considerable risk for retired people living off a fixed income. Having an additional "savings bucket" provides another account to tap into. Remember, more options are better than less, or worse, having none.
With the recent passage of Secure Act 2.0 (SECURE 2.0), beginning in 2024, any unused funds in a 529 plan can be rolled into a Roth IRA, returning funds to the 529 plan owners for retirement purposes. This helps with a parent's biggest concern about overfunding a 529 plan. For example, if the child gets a scholarship, school expenses are less, some funds are unused, or the child chooses not to go to higher education after secondary school.
There are limitations, though: the transfer is subject to the beneficiary's annual contribution limit and up to the lifetime maximum of $35,000. Also, the 529 plan must be open for 15 years or longer.
Regarding your overall retirement plan, you want to start early. The earlier you begin, the power of compounding interest will work its magic for you. It's all math, and guess what we learned about this subject of compounding interest in school from educators.
2. Create Tax-Free Income During Retirement
One of the benefits of a Roth IRA is that withdrawals from the account are tax-free once you are 59 ½ and keep the account open for at least five years. Having a Roth IRA provides one tax-free retirement income source. Who doesn't like tax-free income?
If you participate in a 403(b) and/or 475(b) while also perhaps receiving an educator's pension and Social Security, it may push you into a higher tax bracket. It may cause you to be in a higher tax bracket than where you are now.
A Roth IRA provides retirement income that will not affect your tax liability. If anything, it offers tax-free income if you do move into a higher tax bracket because of your retirement distribution. To ease being pushed into a higher tax bracket, at minimum, you need to take the required minimum distributions (RMDs) of your 403(b) and/or 457(b). A Roth IRA may provide the flexibility to cover your retirement expenses while taking the minimum RMDs.
3. Adds More Diversification to Your Investments
A 403(b) and 457(b) lack the robustness of investment options. One of the most common themes we see with our educator clients is that retirement plans offer limited investment options. To take it further, many of these 403(b) and 457(b) retirement plans are from insurance companies. As a result, the investment options limit you to insurance annuities or target-date funds with high investment fees. Although some plans offer mutual or exchange-traded funds (ETFs), the list is small, and the former may have high load fees.
A Roth IRA breaks away from the limited list of investment options as you have complete control over managing the account yourself or have an investment professional handle it. Almost all brokerage firms offer the option to open a Roth IRA and offer unlimited investment choices (stocks, bonds, alternatives, etc.).
4. More Control Over Your Money
Like most employer-sponsored retirement plans, there is little control over them (see the previous point). However, 403(b) or 457(b) is a long-term savings strategy. Surprisingly, people's most valuable assets are their home (if they own one) and their retirement plan, which means that most wealth (money) is in these assets.
Most employer-based plans limit your access to funds, but some give you access to take loans against retirement money. When you take a loan out of your retirement account, you are essentially paying yourself at a fixed interest rate, but some origination fees may go to the plan administrator and are not paid to you.
Consider the following situations: you want to buy a home and would like to increase your down payment, need to pay unexpected bills, need additional funds for putting a child through college, or you, unfortunately, become disabled and need money to cover medical bills. A Roth IRA provides an extra emergency fund (you should have one already). In addition, the uniqueness of a Roth IRA allows you for an early distribution penalty-free (more on this in the next point).
Having a Roth IRA gives you the freedom and flexibility to access your funds without dealing with the paperwork for a loan or asking for a hardship withdrawal from a retirement plan administrator.
5. Early Distributions Penalty-Free Emergency Fund
As mentioned in the previous point, the Roth IRA is unique and allows you to receive early distribution penalty-free. Therefore, you may withdraw early and not be subject to income tax and/or a 10% early withdrawal penalty.
There are two requirements for a qualified early distribution. The first requirement is that the Roth IRA account is open for over five years. The others are you have an exemption from taxes and penalties if you become disabled when the distribution occurs. The other is if you use the distribution towards purchasing, building, or rebuilding a first home. If used for a home, there is a limit of $10,000 per lifetime.
The other early distribution is based on your contributions. According to the IRS Roth IRA order rules, distributions of regular contributions are always tax-free and penalty-free. When you withdraw, the first funds taken out are your contributions.
For example, you have $30,000 in a Roth IRA. Within the Roth IRA, $20,000 is your contributed amount, and the other $10,000 is investment earnings. You decide to withdraw $18,000. Since $18,000 is less than $20,000 from contributions, these withdrawals do not create any tax situation or penalty. The Roth IRA is the unique retirement savings account allowing this type of withdrawal.
Consider now that if you want to withdraw an additional $5,000 later, from this, $2,000 is tax and penalty-free, while $3,000 would be subject to taxes. Also, if you have not reached 59 ½, you will be subject to early penalties and taxes.
Taking early distributions like in this scenario is not something you would like to think of as a standard distribution strategy that should be a last resort – an emergency fund. But remember, the more options you have, the better.
Always talk to your tax professional if you do this emergency distribution.
6. No Required Minimum Distributions
You can't keep retirement plans in the state of tax-deferred forever. Eventually, taking the required minimum distributions (RMDs) would be best. As of 2024, the RMD age is 73, meaning you must take distribution even if you do not need the money. The Roth IRA is the only retirement account not subject to RMDs.
The RMD amount is based on a Uniform Lifetime Table from the IRS and uses your remaining life expectancy, which means as you age, the RMD increases. A Roth IRA allows you to have at least one account within your retirement plan that is tax-sheltered and not subject to RMDs. You can continue to draw down within the other retirement accounts.
7. Tax-Free Generational Wealth
The Roth IRA allows you to leave something to your heirs based on your estate planning goals and help transfer generational wealth. Like all retirement plans, each account will enable you to name beneficiaries and transfer generational wealth. However, the Roth IRA is the only account that allows you to leave tax-free generational wealth.
The Roth IRA has two categories for beneficiaries: designated beneficiary or eligible designated beneficiary.
A designated beneficiary is a person who inherits a Roth IRA from a parent (you). The beneficiary (your adult child) must withdraw all the money from the account within ten years following your death. It gives your beneficiary the freedom to withdraw the money on their terms. The beneficiary is not subject to RMDs, but the caveat is to deplete the account within ten years.
If your beneficiary does not require the money, they can enjoy ten years of tax-free growth as their withdrawals will also be tax-free.
An eligible designated beneficiary applies to minor children, a surviving spouse, and disabled or chronically ill individuals. Beneficiaries falling under this category take distributions over their life expectancy, also known as stretching the distributions, but they are allowed to take a distribution as soon as they like. The main caveat is if the account they inherit satisfies the five-year test.
In either situation, beneficiaries can inherit tax-free money, which can help them in the long run. As parents, you may want to leave a long-lasting legacy with your children or spouse by transferring generational wealth. If your focus is transferring generational wealth, besides opening a Roth IRA, you must create a financial plan with estate planning in focus.
Your Takeaways
A Roth IRA is robust compared to all the other retirement plans and accounts. You already have a 403(b) and/or 457(b), but adding a Roth IRA to your overall retirement plan strategy may be essential. A Roth IRA is vital as it adds flexibility as your financial life changes and becomes more complex, and having an additional emergency fund is a great option.
We remind our clients that having many options is better than having none and finding yourself in a corner.
You can open a Roth IRA at any brokerage firm and manage it yourself, or an investment professional can manage it.
Free Flowchart
Here's the link to our FREE Roth IRA contribution flow chart to help you determine your eligibility and contribution limits.
At Wolfpack Wealth Management, we're here to support you every step of the way. Whether you're in Denver, Los Angeles, or anywhere in the nation through video conferencing, our accessible wealth management services are designed to help you secure your financial future. Contact us today to learn how a Roth IRA can benefit you and your retirement plan.
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