An In-Depth Look at The Roth IRA
The contents of this page are for educational purposes only and are not to be taken as concrete financial advice. If you’re looking to implement an idea discussed below, please contact one of our advisors.
Overview - Why is having a Roth important?
The Roth IRA has valuable applications for the simplest and most complex retirement plans. The ability to pay taxes now and avoid huge tax bills in the future is invaluable. Roths make retirement income planning simultaneously easier and better. Having “Roth money” alongside “taxable money” (typically 401(K) money for most individuals) allows retirees to make optimized, intelligent choices in the realm of tax planning. Taking out Roth money during retirement won’t affect your tax bracket and could make a big difference in tax savings, while still withdrawing a comfortable amount of money to live off of.
Tax Planning - Savings and Simplicity
Let’s say an unmarried client wants to live off of $60,000 every year during their retirement. Ignoring standard deduction and other tax factors, we would want to guarantee that any dollar taken out that’s ABOVE $44,725 is Roth money. Because of how tax brackets work, any dollar above $44,725 will be taxed at 22%, while any dollar below $44,726 is taxed at 12% and then 10% for any dollar below $11,001. Clearly, we’d like this individual to avoid paying 22% in taxes on a portion of their money, so we opt to take - at the MOST - $44,725 from their taxable money (traditional IRA, 401(K), etc.) and to meet that $60,000 the individual wants, we’d take AT LEAST $15,275 ($60, 000 - $44,725) from their Roth money pool. If the Roth money pool is much larger than the taxable money pool, we can always pull more from the Roth money, but this instance simply demonstrates that SOME of the money should be Roth money, if possible.
If we implement this tactic over the course of the individual’s retirement, the tax savings can add up quick.
For simplicity, let’s assume the tax brackets remain the same from year-to-year and our client continues to withdraw $60,000 every year. As long as we keep the money out of the higher tax bracket, we’re effectively getting 10% in tax savings every year. This is because we’re keeping the money from being taxed at 22% and only letting the tax rate get as high as 12%. If that $15,275 we were pulling out of the Roth was taxed at 22%, it would amount to an additional $3,360.50 in taxes. If we instead held that $15,275 until it is taxed at 12% in the coming years, it only amounts to $1,833.00.
In short, by keeping our taxable money withdraws BELOW the 22% bracket, we’re getting $1,527.50 in TAX SAVINGS every year.