Your Questions, Answered: Roth IRA vs Traditional IRA

November 24, 2020

On this week’s episode of Your Questions, Answered Rachel Kowalczyk and Brian Leitner discuss Roth IRA and traditional IRA, and answer the following question:

“What is the difference between making contributions to a Roth IRA and converting a traditional IRA to a Roth?”

Do you have questions you’d like answered? Email them to [email protected], and we’ll provide answers.


Brian Leitner: So, Rachel, the question of the day is, “How do I understand the difference between making contributions to a Roth IRA and then converting traditional IRA assets to Roth IRA assets?” 

Rachel KowalczykGreat, great question, Brian. And really there’s, there’s some confusion out there around that. And so basically anyone can do a Roth conversion, which is simply taking traditional IRA dollars and converting them to a Roth. While a Roth contribution is actually directly contributing dollars into a Roth IRA, but there are income limitations to that. In terms of, if you make X amount of dollars. In addition, there’s also a maximum amount you can contribute and that changes each year, but it’s a much lower dollar amount. While the Roth conversion from IRA to Roth, there’s really no maximum amount that you actually are held to in terms of when you actually want to convert those dollars. 

Brian: So, there’s a lot of talk about converting to the Roth. I mean, why would somebody do it? What does that process look like? Can you walk us through that? 

Rachel: Yeah. Great, great question. Really, it’s our job to really pick our head up and see the full picture. So, to your point, it doesn’t make sense for everyone. But for a lot of clients, it does make sense, because if we think of the current tax law and the fact that it’s sunsetting in 2026, the deficit that we had prior to everything that’s gone on this year and the stimulus packages that have rolled out, tax rates are likely going to go up. So, we want to start hedging against future increase tax rates, or maybe today we’d be forced in the 22% bracket. But if the brackets change, we might be forced into a higher tax bracket. The other thing we have to think about is that growth, right? So, if we wanted to convert about $100,000, we’re now taking that $100,000, placing it in a different type of account. That’s growing tax deferred, like I mentioned before, and it’s going to come out tax free. It’s actually not going to be subject to required minimum distributions either. So, the way that we view that is to actually look at it on an annual basis to say, well, gosh, we have X amount of dollars left in a specific tax bracket. So again, let’s use the $100,000 example. Maybe we have $100,000 left in our 24% tax bracket. Well, it makes sense for us to fill up that bracket so that we’re not only diversifying our investments like a healthy investor would do, but we’re also diversifying the types of accounts and the taxation of them to help us hedge against future tax rates. And so that’s one piece of it. The other piece too, is to say, well, gosh, if I have a taxable estate, but it’s mostly IRA dollars, how do I make sure that my estate level is actually after tax versus what the government would view that at? So, we want to make sure that really, we have the right makeup of the types of accounts that really helps set us up for success in the future. 

Brian: Rachel, that’s terrific. You know, as we wrap up here, folks want to make sure that again, it’s right for their own situation. They should really speak with a wealth advisor who understands what this looks like and how it impacts their overall situation. Because again, it’s these aren’t decisions that are made in a vacuum, especially as you talk about, you know, the taxation of a taxable accounts versus the Roth. And when you pull the money out, not only are you not paying taxes here, but it may lower your overall AGI versus having all of your money and just taxable or tax-deferred assets. That diversification, you’ll be able to legally manipulate your taxes later on down the line. But things to consider, especially, how you pay for these assets, the conversion itself, anything you want to mention there? 

Rachel: Yeah, absolutely. So, something that’s really important is, if we want to target a certain dollar amount to be converting, we want to convert that full dollar amount. So, for instance, let’s say that we were going to owe $20,000 worth of tax for a $100,000 conversion. Well, we want to have that full $100,000 converted. So that’s growing and that’s more of a benefit to us and really, we’d rather pay that tax out of a different account. So, whether it be a taxable account, things along those lines, we’d prefer to do it that way, because now we’re getting even more bang for our buck for that full dollar amount converted versus having a $100,000 conversion and now only $80,000 in that conversion amount. And there’s other things we layer into that too. Are we going to move in retirement? Does the other state we’re moving to have higher retirement income tax rates or is the state we’re living in now not tax that? So, it makes even more sense of an impetus for us to do this now. And there’s a lot of different layers that, again, it’s truly meant to be customized on a per individual basis. And that’s really where we come into play. 

Brian: Rachel, thank you. Very interesting. Very helpful. And just to make sure that folks understand that the last bit of information that’s out there where this confusion is when you reference the $100,000, you specifically said the amount that you’re converting, it doesn’t mean you’re converting the entire amount. So again, another idea is to do it over a period of years, again, depending upon what your situation is. 


Brian: Rachel, thank you very much for being here. We really appreciate it. 

RachelNo problem, it was a pleasure. 

Brian: Okay. So, not necessarily sacrificing the returns and, you know, as a prediction, I know a lot of folks that are out there are saying that most companies that aren’t necessarily socially responsible today are certainly taking steps to sort of maybe move closer down that road as time goes on. Right? 

RachelYeah, I think so. And I think it’s coming from two angles. I think consumers are starting to request it a little bit more and I think employees are starting to request it a little bit more. And, you know, as the environment changes or you go through kind of tough economic times perhaps, or other tough health times, you know, as we’ve seen recently that you see a lot of companies just stepping up and saying “Hey, I want to do the right thing by my employees, my customers and stakeholders.” 

Brian: And if anyone has questions they’d like answers to, please feel free to email us at [email protected]. Thanks for watching. 

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