Investing can be intimidating. A big portion of that stems from the fact that it can seem like investors are speaking another language--one that doesn’t come with a glossary! That’s why I’m going to use this episode to demystify all things Roth. By the end of the show, you’ll understand the “Roth treatment” and you’ll have a better sense of how some of these money moves might fit into your financial plan.
Several different retirement accounts can get the Roth treatment. What exactly does that mean? With a Roth account, you invest after-tax dollars. That means that you pay taxes when you earn the money and your money grows tax-free after that.
One of the most common Roth accounts is a Roth IRA. IRA stands for individual retirement account. That means that you are the owner of the account and your investing is not tied to your employer. Instead, you open your account through a custodian, such as Vanguard or Fidelity. The money you invest in your account is after-tax money. That means that your money grows tax-free and you do not pay taxes when you withdraw money--your contributions or your earnings--in retirement.
Of course, there are certain restrictions surrounding the Roth IRA. Each year, there is a set amount that people can invest. Plus, there is an income limit based on your MAGI (modified adjusted gross income) that determines who is eligible for an account.
If you aren’t eligible for a Roth IRA, it is possible to use a process nicknamed a backdoor Roth. To do this, you open and fund a traditional IRA, and then you immediately convert it to a Roth IRA. As with anything regarding investing and taxes, there are certain parameters that need to be adhered to in order to avoid paying taxes or incurring penalties.
In addition to a Roth IRA, you might also be able to open a Roth 401k or a Roth 403b. These function the same as a 401k or 403b, except they are funded with after-tax dollars. That means that you cannot use your investments to lower your taxable income for the year. However, your growth and withdrawals from these accounts are tax free.
Come along with me in this episode to learn more about the rules and regulations surrounding Roth accounts. By the end, you should find yourself feeling more confident about these terms. Of course, you can always consult with a tax professional as well.
In this episode, we also explore:
- Who is eligible for Roth IRAs based on the 2020 IRS rules
- How much you can invest in a Roth IRA or Roth 401k for the 2020 tax year
- Required minimum distributions (RMDs) and why it’s so special that Roth IRAs don’t have them
- A deeper dive into the backdoor Roth process and how to avoid a taxable event
- What a Roth conversion is and when you might want to make one
Featured on the episode:
- Check out the IRS Form 8606.
- Review the IRS guidelines for Roth IRAS in 2020 here.
- Dig deeper into Roths in this blog post.
- Take a look at how easy Vanguard makes the backdoor Roth in this post.
- Grab this tutorial on how to do a backdoor Roth.
- Learn more about how to manage your mindset with Wealthy Mom MD.