“Retirement is wonderful if you have two essentials – much to live on and much to live for.” – Unknown
You might already have an investment plan for retirement, but are you getting the most out of your retirement account? If you have a traditional IRA, you probably aren’t. For most, a Roth IRA offers distinct advantages over its traditional counterpart. Unfortunately, the IRS doesn’t allow high-earners to open Roth accounts, right? Luckily, there’s still a way you can legally open one and Emperor Investments makes it easy. But before we get to that, let’s first examine the differences between traditional and Roth IRAs.
A traditional IRA is tax-deferred and can reduce your gross taxable income during the tax year which you contribute in. All future distributions (withdrawals) you make will be taxed, including growth from dividend reinvestment and capital gains. Additionally, any distributions before age 59½ that are not exempt will result in a 10% penalty. A traditional IRA also requires minimum distributions beginning at age 70½. After you reach the year in which you turn 70 ½, you can no longer contribute to your traditional IRA. That shouldn’t be an issue for most since retirement age in the U.S. is currently 66 ½. However, with increasing lifespans, you never know when that could change and if traditional IRAs will follow.
On the other hand, contributions to a Roth IRA are made after tax and do not reduce taxable income. Taking distributions from a Roth IRA is also slightly different. While you’ve already paid taxes on contributions, you might still be charged the 10% penalty unless you make a qualified distribution. However, unlike traditional IRAs, there’s no age limit for making contributions. As long as you have earned income, you can continue contributing to a Roth IRA.
Perhaps the most advantageous feature of Roths is that although you pay taxes up-front, your money grows tax-free. This means that any capital gains and dividends from your stocks are 100% tax-free as well! Over the long run, this can make a huge difference. Take this example from Forbes into consideration.
‘The image below shows an account value of $10,000. It’s invested in a stock that grows 6% annually and pays a 3% annual dividend (dividends are reinvested). Assume a 20% dividend tax rate. After 20 years, the Roth IRA balance is $56,044 whereas a regular account is $50,186.’
The more you invest, and the more earnings generated by your investment portfolio, the greater your tax savings would be. Since Emperor tailor-makes portfolios designed to outperform and earn dividends, a Roth IRA is especially beneficial to their clients.
So why doesn’t everyone choose to have a Roth IRA? As mentioned previously, there’s an income limit. For 2019, single tax filers must have a modified adjusted gross income (AGI) of less than $137,000 to contribute to a Roth IRA. Married couples filing jointly must have modified AGIs of less than $203,000 in order to contribute. Don’t qualify? Don’t worry, you can still take advantage.
The Backdoor to Tax-Free Dividends
High earners who don’t qualify based on their income have another option—the backdoor Roth. As of 2010, the IRS has not specified income limits that restrict who can convert a traditional IRA to a Roth IRA. As a result, taxpayers who ordinarily couldn’t contribute to a Roth can instead make a non-tax-deductible contribution to a traditional IRA and then convert it to a Roth IRA. Another way to make a backdoor Roth contribution is by making an after-tax contribution to a 401(k) plan and then doing a rollover to a Roth IRA. It’s important that your traditional IRA or 401(k) contribution is after tax, that is, not tax deductible in the year it is made.
This might sound a bit confusing, but Emperor can make it easy for you. One of their portfolio managers will gladly walk you through the process if you’re looking to open a backdoor Roth with them. They’ll also process your transfer quickly and cover any transfer fees you might incur. You can email them at firstname.lastname@example.org or call 1-855-588-7577 to learn more.
In general, the advantage of a backdoor Roth funded with after tax contributions is that you shouldn’t owe any additional taxes since you’ve already paid them upfront as part of your income. But if you’re converting previously tax-deferred contributions from a traditional IRA or 401(k) to a Roth, you’ll very likely owe some taxes in the year you convert or roll over. Consult your tax professional for advice specific to your unique situation.
To Roth, or Not to Roth?
Deciding between a traditional and a Roth IRA really depends on how you think your future income and income tax bracket will compare to your current situation. In effect, you’re guessing whether the tax rate you pay on your Roth IRA contributions today will be greater or smaller than the rate you’ll pay on distributions from your traditional IRA after you’ve retired (or are forced to start making them at age 70½).
Of course, it’s impossible to predict what federal and state tax rates will be 10, 20, or 30 years from now. But with the current historically low federal tax rates and the large U.S. deficit, many experts believe federal and state income tax rates are likely to rise in the future. This means that Roth IRAs may be the better long-term choice, especially if you expect your income to rise over time.
If you take anything away from this article, it’s that regardless of what the future tax rates are, with a Roth you’re still only paying taxes on your contributions which means your earnings always grow tax free. And for most, that’s the main reason they want to open a Roth IRA. You can open one up with Emperor Investments within 10 minutes and start investing in stocks today by clicking here.
Martha Brown Menard, PhD, is a research scientist, financial coach, and dividend income investor. She takes a smart beta approach to building her own portfolio, and likes seeing her income stream grow.