What Is Roth?

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CardinalGuide.com, Cardinal Advisors, and Hans Shile, CFP, sell insurance. This show does not offer investment products or investment advice. Welcome to Finishing Well with certified financial planner Hans Shile. A very fun show today, I think. It may sound dry at the beginning, but believe me, sit tight. You'll buckle up your seat belt.

It's going to be fun. The question today is, and the show's title is, What is a Roth? And you may know that a Roth is a Roth IRA. We're going to get into lots of that kind of thing, but as always, you know, we want to take a look at the scriptures and see what we can see here. And actually, Hans and I talked at length about this, about how fun this topic is from this standpoint of thinking about, from Matthew 25, the parable of the 10 virgins. And those 10 virgins were waiting, not on retirement, but on the bridegroom, as the case may be. But they were definitely waiting. And 10 of them were smart, right? And they had resources, and they worked hard to get their resources together.

In other words, they put together this oil. And then, excuse me, five of them were smart, and they had plenty of oil. And then there were five that weren't quite so smart. And so you can't help but wonder, you know, what was the hangup for them that they misunderstood what their needs were going to be at the point in time when the bridegroom would show up?

And so with this in mind, you know, we need to be thinking about, and I think it's a great thing to think about, what was the oil that they had? I hope you're familiar with the story, that these 10 virgins were waiting on the bridegroom to come. And when he got there, five of them had plenty of oil. The other five, you know, their lamps had gotten dark because they woke up because they didn't know it was going to be so long. And when they did, the bridegroom showed up.

And when they went to come into the wedding feast, well, it was weeping and gnashing of teeth. So the idea is, how do we, number one, get that oil, and how do we not be foolish? And so it has to do with this idea of waiting and not instant gratification necessarily, but considering what our needs are going to be as things approach. And so with that in mind, it's very helpful, in my opinion, this concept of a Roth IRA in my own personal life. When I learned about this, it just made all kinds of sense, especially at my age, and me still working.

So I'll let you take it from there, Hans. Yeah, so we're talking today about the Roth IRA. We've talked about it a lot on the show, and I think we've just kind of skipped over, like, what it is exactly. Not skipped over it, but just went over it quickly, and then we were talking about how we apply it, how we benefit from it, how we get it, how we convert to it. We've been all around this issue. The first thing I want to tell people is the Roth IRA started in 1997, so it's 25 years old this year, and it was named after William Roth, who was a senator that was a sponsor of the bill.

And there you go. So why would he be doing this in 1997? And we can only guess, but the IRA itself was started in the 70s, so the things had been around 20, 25 years, and people had accumulated money in there, and back in those days, you could only put like $2,000 in the thing, and I think even back in the 70s, it might have even started at $1,500. But you could put 401ks, and people were building up some balances, and this whole tax-deferred thing, this whole business of it, you got to write off the contribution, or you didn't pay taxes on the money going in, and then it accumulates tax-free.

I think 25 years later, after the thing started in the late 90s, they were really, Congress was looking at this thing and saying, you know, we've got these retirees accumulating money, and now they're going to have a big tax bill, and furthermore, we're not collecting any taxes now on all these billions or trillions that are in this thing, so they decided they're going to come out with an alternative. And the alternative, being the Roth, and like I said, passed in this legislation named after the dude, so it's 1997, the contributions are after tax. So, you know, when you put $6,000 or people over 50 can put in $7,000 just into a Roth IRA of a direct contribution, you're doing that with after-tax money.

So, if you're putting in seven grand, you had to make like 10 or 11 or 12 to net the seven that you're putting in there at the beginning of the thing. So, it clearly can be looked upon negatively in that you might be better off putting the seven grand in there in a traditional IRA, and then you get to take that off your taxes. And people have been all over that for years, and many of you sitting there right now, you've got all your money, or most of your money, in a 401k or a traditional IRA, meaning you haven't paid tax on that money yet. What I'm talking about in a Roth is you've already paid tax on the contributions, and then on the growth, you're never going to pay taxes. Does that make sense, Robbie? Yeah, and that is, you know, to me, one of the fundamental things about it that's really cool is that, number one, since you've paid tax on it means you're going to get it back out without paying tax on it, but also the idea of that those earnings, the benefit that they're giving you by doing this is those earnings, well, you'll never pay tax on those, which is different than a traditional IRA.

It is absolutely different. And, you know, people that respond negatively to my communications, which there's plenty of them, you know, there's plenty of people that don't agree with me on a lot of things, but on this particular issue where I'm kind of like touting Roths today, and I'm showing the benefits of paying the taxes now, having the after-tax contribution, then having the after-tax growth, and then the distributions in retirement are totally tax-free, and then what the counter to that is, they're going to say, well, your tax rate is lower, excuse me, when you retire, so it's higher while you're working, so do a traditional IRA, because you can deduct it when your tax rates are high, and your tax rates are going to be low when you retire, and therefore you're wrong, Hans. I mean, it just, maybe they don't add that last little part, but that's the agreement. I've had many CPAs tell me that, even my own CPA. You know, paying taxes now, paying them later, later is better, now is worse than later.

I mean, that's just, that's the logic. Yeah, a couple things I got to say to that is that's not always true, and in the current environment, you know, the top of the 24% tax bracket, federal tax, for a married couple is $340,000, and the top of the single tax bracket, the 24% is $170,000 of income. So, federal tax at 24% is pretty low to me, and I don't make more than $340,000 this year, maybe I used to a long time ago, but, so, I'm just thinking 20 years from now, when I'm, I don't know, 83, or even 15 years from now, I'm thinking I'm going to be paying more than 24% tax rate. We don't want to get into that on the show too much today on tax brackets, that's another show, but that's the first part of that argument that I don't always agree with. The second part is these people are ignoring the earnings. So, I mean, most people that come into me, and let's just say they got a million dollar 401k, just to make the math easier, they got a million dollar IRA, and we have a lot of those people with the way the markets have gone up. So, they're sitting there, and they're looking at this, and now they're talking to me about a Roth conversion, and, you know, when we break down that IRA, it's kind of hard to do this, but we can do it, and how much of that was contributions that were tax deductible, and then how much of it was earnings inside the IRA, and I'm going to tell you that about 30, 40% of it was contributions, and the other 60% was earnings on those contributions over many, many years. That make sense?

Exactly, yeah. And if that had been a Roth all along, which wasn't an option back then, so I'm not doing Monday morning quarterbacking, but if you're doing this comparison, if that had been a Roth all along, sure you would have paid tax on the 300 to 400 grand that you put in there, but all of that earnings would have been tax free, and because it's in a traditional IRA, you're going to have to pay taxes on every dime that's coming out of there, and what I've found in my experience is people that have large IRAs, they are really slow to take money out of there. They just, you know, this whole, they don't want to do it, and they wait till 72 when they have to, and then they take out the minimum, and then many years go by, and the thing keeps growing, and then they pass away, and it goes to their kids, and their kids have this gigantic tax bill, okay? I mean, that's the tax bomb, and so I just want you to follow me on these ones. I've moved a little bit into salesperson mode, where I'm pitching these things, but I'm just, let's just look at this thing objectively and say we got an account that we can open. We got to incur some pain to get it started, meaning we got to pay tax on the money and put the after-tax money in, but it is now a tax-free forever account. It's almost too hard to pass up.

No, it's wonderful. So let's go through a few benefits of this thing. I mean, it, there are no required minimum distributions on this, so on your Roth portion of your account, or your Roth IRA, when you reach 72, you do not have to take any money out of it, ever. You can just let it sit there until you die, if you wanted.

I mean, that's a big advantage. If you're over 50... Yeah, which, by the way, if you're sitting there and you don't take money out of it, right, then its earnings are bigger, which are also tax-free for whoever your heirs are, right? Right, and now your heirs are going to have to start pulling some of it out, but they've got 10 years to do it, and when they do it over the 10 years, they're not paying any taxes on the money either.

I mean, it's just, it's like this account that a lot of people, when they really think about it, didn't know existed, okay? Now, I'm going to tell you that you can put $6,000 every year into a Roth, even if you're in a retirement plan at work. You can put $6,000, and you, as long as you have service income of that much, so you have to be working to do that, and if you're over 50, that number is seven, seven grand, and you can do that, like Rhonda and I can do that on both of us, so it's really $14,000 that we can put in $7,000 in mine, $7,000 in hers. I'm going to have to jump in, because we're about at break time, I'm sorry. So we're going to leave you there at $14,000, but what a cool thing these Roth IRIS are. I think you're going to really enjoy what we've got coming. We want to remind you that the show is brought to you by cardinalguide.com, and of course, Hans' YouTube channel, where there's a video right along these lines, it's Cardinal Advisors at YouTube. So when we come back, we've got a whole lot more to share along the lines of the Roth IRA.

We'll be right back. Hans and I would love to take our show on the road to your church, Sunday school, Christian or civic room. Here's a chance for you to advance the kingdom through financial resources by leveraging Hans' expertise in qualified charitable contributions, veterans aid and attendance, IRAs, Social Security, Medicare and long-term care. Just go to cardinalguide.com and contact Hans to schedule a live recording of Finishing Well at your church, Sunday school, Christian or civic group. Contact Hans at cardinalguide.com.

That's cardinalguide.com. So welcome back to Finishing Well with certified financial planner, Hans Seil. Today's show, What in the World is a Roth?

And we're getting into some really cool details. Hans, when we left our hero, you were talking about how much you could contribute each year, especially, you know, once you go over 50, you can do $7,000 apiece if you're married, right? $14,000. You can, so long as your combined, excuse me, your individual income, if you file single, is $144,000 a year or less. Or for a married couple, if they're both working, or just their combined income, $214,000 or less.

So there's some limits. The people that make a lot of money can't make these off-beat contributions, but the people under those amounts, you can put away seven grand a year each. And you could do that right now. In fact, right now, if you haven't filed your tax return yet, which most people haven't, you can put in seven grand for 2021, and you can put seven grand for 2022. So you could put 14 grand and start this tax-free account for both you and your spouse, okay? So just a way, if you wanted to get one started, I'm going to tell you something else you could do if you don't have a Roth IRA, is you could put a hundred bucks in one, or a thousand bucks in one. And I'm going to show you how that would benefit you, because there's this thing called the five-year clock.

So all these things with the government, and the IRS, and taxes, and investments, they all got all these little kind of weird rules that I've spent my life studying. And one of them, there's a five-year rule with the Roth. So it goes by the very date that you first opened your first Roth IRA. So even if you put a hundred bucks in there, and you did it, you know, March 1st, then during 2022, that's the year you opened your first Roth IRA. And then if you took any money out of there before 2027, you would have to pay taxes on the gains. So what they're really doing with this rule is, once you open a Roth, you've got to leave the money in there for five years. That's a simpler way to understand it. And if you put a hundred dollars in now, and then you put a hundred thousand dollars in, you know, three years from now, your five-year clock started now.

Okay. Now when you get 65 and over, you got to deal with Medicare, and you got to deal with Social Security, or you collect Social Security, and you have to deal with taxes on both of those things. If you have a higher income for IRMA, which is the Medicare tax, and then just plain old income taxes on your Social Security check, then Roth IRA income doesn't count toward those. It's just, I mean, it is really tax-free, and that's part of my plan, as you well know. Now, the earnings that are accumulating in there are tax-free. When your beneficiaries receive the money, they have 10 years to distribute it to themselves. So they can't leave it in there indefinitely, but they can leave it in there for 10 years, and they can leave it all in there till the 10th year, and take it all out in the 10th year, so it can accumulate more tax-free. I mean, most of them aren't going to wait 10 years. Most of them are just going to cash the check in the beginning, but they could take part of it.

The point being, it's going to go 10 years beyond your lifetime, this tax-free game, and it could, which is sweet. You can convert traditional IRA, or traditional 401k. We make a huge business with this. It's just about everybody that comes in here that hires us to do a financial plan, typically in their 60s, some in their 50s, some in their 70s.

Just about everybody says, how do I get these raws? How do I convert this big, huge IRA that I have, or this smallish IRA, how do I get it to a raw? Well, first, before we tell you how, we're going to make sure it's the right thing for you to do, and then if it's the right thing for you to do, I can tell you it's going to be over several years. It's going to make it the best tax-wise, but there is no maximum on the amount that you can convert. A lot of people mix this up, they think that, you know, this $7,000 max, or there's some sort of a rule they can only do so much. No, if you had a million dollars in an IRA, and you wanted to turn it into a Roth, you could do the whole thing all in one year. The only problem with that is you'd have a tax bill of about $350,000. So, I don't think you want to do that. I think it'd be smarter to do it 100,000 a year for 10 years.

I mean, we'll talk about that when you come in, okay? Paying tax from the IRA, or from other money. So, if you're doing a conversion, let's go back to the million dollar guy, or million dollar lady.

They want to look at a conversion. They decide to do it all in one year. So, the real issue is, are we going to have $650,000 in this Roth IRA because we paid the $350,000 of tax, I'm just guessing at that, out of the IRA money? Or are we going to have a million dollars in this Roth IRA because we paid the $350,000 out of other money?

That's why we spread it out over a number of years. You got to add the state income tax to that. If you're in a state that has an income tax, North Carolina does. South Carolina does. Virginia does. I mean, Florida doesn't. Nevada doesn't. Texas doesn't. So, there's a number of states where there's no state income tax, but most of them do. And here in North Carolina, it's a little over 5%. So, you're going to have to pay that too.

Your conversion, like I said, is spread over a number of years. A lot of you folks that have 401ks and you're still working and you're making contributions, a lot of folks are not even aware that there's such a thing as a Roth 401k or a Roth option within your 401k. So, you can start making contributions out of your paycheck.

You could set this up maybe next week. You could have them start taking that money they're pulling out of your check, putting it into your 401k, put it into the Roth portion. And when they do that, your check's going to get a little smaller because you're not getting the tax benefit now. You're going to get it later.

And that goes back to Robbie's basis. We're talking about patience and waiting, you know, waiting for the bridegroom to come. You know, I think about that a lot. That, wow, if to be 35, 40 years old, realize this with your 401k at this point in your life, and as you say, those, yeah, you're paying a little more tax on it, no doubt, but you're paying it at these tax rates. And then those earnings, as they grow, like, oh my goodness, and that's all tax free. As you talked about, the substantial amount that, that happens by the time that they're in that stage of life. And so, you know, this is really helpful information for a lot of folks that are a lot younger. Oh yeah. I mean, it's, it's, it's a sweet thing. Now, now when you get into the issue, do I convert all of it?

And the answer is probably no. And us Christians, you know, we, we, we, we like to, you know, and we're, we're, we're called to give money to, to God and to tithe and to give money to the church. And we get into this thing of the QCD. And so you want to keep some money in a traditional IRA so that you can do a QCD when you're 70 and a half.

And, you know, we'll get into that in another show. You also want to take a little bit of income every year out of a traditional, because when you have a smallish income, when I say like 10,000 a year, you don't pay much taxes when you're 72 or 70 or something on $10,000 a year. So you're, you're still going to want to create a little income out of that traditional IRA. You just want the bulk of it to come out of the Roth so you don't have to pay taxes on.

Right. And then what we want to talk about is when you've got these two accounts, let's put the stocks that are going to grow inside the Roth and let's leave the conservative money inside the traditional account. So if we have a balance of investments, that way we won't have to pay any tax on when those growth stocks go way up, that's going to be a tax-free growth. So that's kind of what we can talk more about that later. And then, you know, the conservative stuff, we want inside the traditional IRA.

I'd recommend people learn all they can about this. And just about every client that comes in, we talk about a Roth strategy. Now the people that have smaller numbers, like I think of a lady that I'm helping and she's got a little over a hundred grand in IRA money, about 130, and you know, we're working on her social security. She's got a little bit of other money and things are pretty tight with her.

Okay. And she's working part time. And so, no, I'm not doing Roth conversions for her because she can pull out, you know, the five, six, seven, eight, nine, ten thousand dollars a year that we're going to pull out of the IRA and pay almost no taxes on that and no taxes on her social security.

So it wouldn't be any benefit for people that have smallish balances to get into this Roth conversion. So Hans, as people get prepared, right, for, in other words, they want to have enough oil, you know, where we actually begin to harvest this money is where it really comes in handy. Whether we're putting together the money for ourselves or putting it together for our heirs and beginning with the end in mind, so to speak, of going, what are we preparing this for, right? Yeah. You know, I think it's going to be great to have social security income almost tax free or a little bit of tax and then have another income on top of social security that is tax free is going to be sweet in my seventies and eighties.

I mean, it just it just is. And it's going to provide a lot of security. And then if we don't need to drain down the Roth to be able to give tax free money to my kids is just wonderful. Right. They're not inheriting an IRA where they also owe.

Yeah, it could be, you know, a lot if it's a large IRA, it could be 40% by the time you had the state income taxes. As usual, we've run out of time before we ran out of show, but we're so grateful for you listening today. And we want to remind you that you can find out all about this kind of thing with Hans's book, The Complete Cardinal Guide to Planning for and Living in Retirement. It's there at cardinalguide.com and, of course, more helpful videos at Cardinal Advisors.

So just look for that on YouTube and you can find out more about it. Thank you so much, Hans. Yeah, thank you. God bless.

Yeah, God bless you. Finishing Well is a general discussion and education of the issues facing retirees. cardinalguide.com, Cardinal Advisors, and Hans Schleil CFP sell insurance.

This show does not offer investment products or investment advice. We hope you enjoyed Finishing Well brought to you by cardinalguide.com. Visit cardinalguide.com for free downloads of this show or previous shows on topics such as Social Security, Medicare, IRAs, long-term care, life insurance, investments, and taxes, as well as Hans's best-selling book, The Complete Cardinal Guide to Planning for and Living in Retirement, and the workbook. Once again, for dozens of free resources, past shows, or to get Hans's book, go to cardinalguide.com. If you have a question, comment, or suggestion for future shows, click on the Finishing Well radio show on the website and send us a word. Once again, that's cardinalguide.com, cardinalguide.com. This is the Truth Network.