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The Roth IRA Movement

Today is a special day in the world of Personal Financial Blogging. As my regular readers know, I’ve expressed mixed feelings about the Roth IRA. When I read articles telling me that a couple converted a million dollars to Roth, slamming themselves into the top bracket (35%, and possibly higher, through the effect of AMT) and then financing the tax due, I realized that some sanity was in order. Level headed discussion about how to best benefit from this type of retirement and not go too far in the other direction. I realized that far more discussion was in the future than I’d want to write in one place as I’m trying to maintain a variety of topics here. So, I planned to launch RothMania, a new blog dedicated solely to the Roth IRA and Roth 401(k) and how they can help you reduce your lifetime tax bill.

Today is the launch of the new RothMania site. Coincident to this, Jeff Rose of Good Financial Cents has coordinated The Roth IRA Movement a day in which Personal Financial Bloggers are all writing articles on the Roth.

At RothMania, to celebrate the occasion I’ll be giving away copies of Ed Slott’s The Retirement Savings Time Bomb. All you need to do to be eligible is ask your question regarding the Roth IRA.

If you are new the Roth, Let me start getting you up to speed. The Traditional IRA typically is funded with pre-tax money. If you are in the 25% marginal bracket, this means you are out of pocket $3750 in order to put away $5000 into your IRA. It grows tax-deferred, but is then taxed on withdrawal. The assumption is that you will be in a lower bracket at retirement and therefore save money. That said, the Roth IRA is the mirror image of this. A Roth lets you deposit money you’ve already paid tax on, but then the growth and eventual withdrawals are not taxed again.

That simple, Joe? Uh, hardly. You see, both flavors of IRA have Phaseouts, where for the traditional, you may not be permitted to deduct the IRA deposit from your income, and for the Roth, where you can’t deposit at all. Then there are the choices that come with being able to convert the traditional IRA to Roth, and the tax implications of these conversions. In the end, there’s no “one size fits all,” but there is a best strategy for each individual situation, and that’s what needs to be determined on a case by case basis. Let’s look at a short few examples of the IRA no-brainer, the times it’s not tough to decide what’s right.

  • You are just above the AGI limit ($112K MFJ, $68K Single) for a Traditional IRA deduction. Time to make that Roth deposit.
  • A dependent child has low income, and would otherwise have no tax due. She can deposit up to the lesser of $5000 or her total income to a Roth, and jump start her retirement savings.
  • A retiree, single, with a 2012 taxable income of $25,000. She can convert from Traditional IRA to Roth enough to get her taxable income up to $35,350. This would tax the difference of $10,350 at 15%, and avoid the potential of having ever increasing RMDs put her into the 25% bracket.

  • Gregory Harrop April 3, 2012, 10:21 pm

    Dear Joe Taxpayer,

    Can you help me?

    Here is what I’d like to do: I want to buy shares directly from a half dozen companies like 3M (MMM) and Johnson and Johnson (JNJ) that issue dividends. I want to have the dividends re-invested into the same companies (DRIPs). I want to set up an automatic checking account so each month a set amount of money can be withdrawn and deposited into a RothIRA account where those monies can be invested into those same companies, thus taking advantage of dollar cost averaging. Dividends are taxable and I want to avoid paying taxes and stock brokerage commissions, even at low cost Internet brokerage firms like TradeKing.com.

    I want to set up a RothIRA account for doing this. I understand that I will need a bank or financial institution to act as a custodian and use the funds in the RothIRA account to buy the DRIP shares or fractional amount of shares each month on behalf of my RothIRA.

    Do you know of any bank or financial institution that will act as the custodian of a RothIRA account and buy the shares for the RothIRA each month? My local credit union does not provide this service.

    Thank you very much. I do appreciate your advice and suggestions.

    Sincerely yours,

    Gregory Harrop

  • JOE April 7, 2012, 9:43 am

    I understand what you are trying to do, but my understanding is that the companies that sell commission-free to small shareholders are not sending those shares to retirement accounts. Perhaps a reader with experience with these programs can shed more light on the subject.

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