Knowing the difference between a traditional IRA and a Roth IRA enables investors to plan effective strategies to maximize returns and to adjust those plans when change occurs, like the recent Secure Act 2.0.
What is a Roth IRA?
A Roth IRA is an individual retirement account to which you contribute after-tax dollars, which simply means that you pay taxes on the money going into the Roth, but future withdrawals are tax-free.
Other criteria and details:
- Distributions are tax-free and penalty free if taken after 5 years and after 59 ½ years old.
- Maximum contribution for 2023: $6,500 and $1,000 additional catch-up contribution if you are 50 years or older.
- Certain income levels prevent contribution.
- Contributions grow tax-free.
- No required minimum distributions.
What is a Traditional IRA?
A Traditional IRA is an individual retirement account that is made from pre-tax or after-tax dollars and defers taxes on your earnings until you make withdrawals.
Other criteria and details:
- Distributions are subject to ordinary incomes tax and may also be subject to a 10% federal tax penalty if taken before the age of 59 ½.
- Maximum contribution for 2023: $6,500 and $1,000 additional catch-up contribution if you are 50 years or older.
- Anyone with earned income is eligible to contribute.
- Contributions grow tax deferred.
- Based on the changes with the SECURE Act 2.0, Required Minimum Distributions must begin by:
- 73 if born between January 1, 1951-December 31, 1959
- 75 if born on January 1, 1960, or later
Planning Strategies for Roth IRAs
What is a Roth IRA conversion?
A Roth IRA conversion involves the transfer of retirement assets from a traditional IRA or 401(k) into a Roth IRA. You must pay tax on the money converted, but future withdrawals can be tax-free.
Are there limitations or guidelines?
Yes. Contributions to a Roth IRA cannot be made if modified adjusted gross income (MAGI) equals or exceeds certain limits ($138,000 for single filers and $218,000 for married couples filing jointly in 2023). However, there is no income limit level to convert all or part of funds in an existing Traditional IRA to a Roth IRA.
What else should I know?
- If you own more than one Traditional IRA, the IRS regards these as one entity and will prorate the cost basis on the conversion amount.
- If the taxes on a conversion are paid using funds from the Traditional IRA, a 10% penalty may apply if the account owner is under the age of 59 ½.
- The amount converted into a Roth IRA will grow tax-free and the distributions will also be tax-free and penalty free if taken after 5 years and age 59 ½.
- After conversion, there are no minimum distributions.
SECURE Act and SECURE Act 2.0
The SECURE Act was passed by Congress in December 2019 and 2.0 was passed in December 2022.
What changed about Inherited IRA Accounts?
- As of January 2020, most non-spouse beneficiaries are required to liquidate inherited Traditional and Roth IRA accounts within 10 years of owner’s death.
How should my planning strategy change?
- Use a Roth conversion as a wealth transfer technique.
- The converted amount will be tax-free income to the non-spouse beneficiary over the 10-year period.
- Work with your MAI wealth and tax advisors to determine an amount to convert that won’t push you into a higher federal tax bracket and increase your Medicare premium payments due to IRMAA (Medicare Income-Related Monthly Adjustment Amount).
What changed about Roth 401(k)/403(b) Accounts?
- Beginning in 2024, catch-up contributions for those with income over $145,000 must be made into a Roth 401(k)/403(b) account. If the employer does not allow for Roth 401(k)/403(b) accounts, these individuals will not be able to make a catch-up contribution.
- Beginning in 2024, individuals with assets in Roth 401(k)/403(b) accounts won’t be subject to Required Minimum Distribution rules.
- Beginning in 2025, the law permits employer contributions to be made into Roth 401(k)/403(b) accounts.
What changed about SIMPLE and SEP IRAs?
- Beginning in 2023, both SIMPLE and SEP IRAs can offer Roth options.
What changed about 529 Plans?
- Beginning in 2024, the law permits 529 plans to roll over up to $35,000 into a Roth IRA. The account owner on the Roth IRA must be the same as the beneficiary on the 529 plan.
- The 529 plan must also be open for at least 15 years, and the amounts rolled over are limited to the annual contribution limits.
There can be beneficial strategies with Roth accounts based upon changes to tax laws with the SECURE Act and the SECURE Act 2.0. Schedule a meeting with your MAI Wealth Advisor to see if these strategies will benefit you.
Information updated as of Friday, June 16, 2023.
Please send your questions, comments and feedback to: info@mai.capital. The opinions and analyses expressed herein are subject to change at any time. Any suggestions contained herein are general, and do not take into account an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Distribution hereof does not constitute legal, tax, accounting, investment or other professional advice. Recipients should consult their professional advisors prior to acting on the information set forth herein. In accordance with certain Treasury Regulations, we inform you that any federal tax conclusions set forth in this communication, were not intended or written to be used, and cannot be used by any taxpayer, for the purposes of avoiding penalties that may be imposed by the Internal Revenue Service.
