8 Not So Vital Things To Know About The Roth IRA for 2008
By CHM on Jan 13, 2008 in Roth IRA Rules
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Yesterday I compiled a list of Roth IRA facts and opinions that I felt were important for you to be aware of for 2008.
Well the following list is a bit different.
Most of these points are fun, little obscure facts about the Roth IRA (I know I’m such a geek) that you may find interesting, but probably won’t influence your decision making one way or the other for 2008.
Unlike Friday, today I won’t bombard you with flowery, circumlocutory language. Let’s get to it…
8 fun facts about the Roth IRA for 2008:
If you have a traditional IRA and a Roth IRA, the amount you contribute to your Roth IRA must be reduced by the amount added to your traditional IRA, and vice versa.
If you’re a married person filing your tax return separately, making over $10,000 a year, then you can’t contribute a red cent to a Roth IRA. That’s right you heard right.
The US government is obviously not a big fan of people with this filing status, and one of the ways they discourage people from trying to find filing loopholes is by taking away your Roth IRA privileges.
Unlike the traditional IRA, contributions can be made to a Roth IRA after age 70 1/2. Also, with a regular IRA you are forced to start taking RMD’s (required minimum distributions) at age 70 1/2.
With a Roth IRA you do what you like, you can take it out, leave it in there forever, whatever you want. This flexibility is priceless for 2 reasons:
- you’re not hemorrhaging taxes back to the US govt. at age 70 and beyond
- it turns the Roth IRA into a powerful estate planning weapon.
HINT: The above reasoning will factor heavily in my next post.
Under IRS Rule 72(t) you can take (SEPP’s) substantially equal periodic payments out of your Roth IRA before age 59 1/2. To qualify as substantially equal periodic payments, the installments must be made at least annually and must be in amounts that do not change before the later of five years after the the payments start or the participant reaches age 59 1/2.
I think an example will do.
(Sometime in the future) Let’s say you have had a Roth IRA for 20 years and it’s the only retirement account you have. You decide you want to retire at age 54 and your only source of income will be the company pension. (Heck, you won’t be able to collect social security for nearly a decade, if it’s still around.)
Under Rule 72(t)… you can agree to take SEPP’s in order to supplement your pension. This way you’re not forced to change your lifestyle, etc. In this case, after age 59 1/2 you are free to do what you like with the remaining monies in your Roth IRA.
Roth IRA’s are subject to the limit of one rollover per year. You’d be surprised how many times people run afoul of simple rules like this.
In addition to the normal rules, for distributions to be qualified, they must not be made until 5 years after the Roth IRA is set up.
Here’s a real life example, I’ve stated that my 7o year old dad recently made his first Roth IRA contribution. Well, he doesn’t have to worry about the normal rules (because of his age) but he does have to worry about the 5 year rule. If he tries to take out any of the account earnings before age 75, he will be hit with penalties.
Starting in 2006, employees can elect to treat their salary deferrals to a 401(k) plan as Roth contributions. Unlike Roth IRA’s, there are no AGI limitations on the ability to designate a contribution as a Roth IRA.
This is a pretty big thing. If you’re not eligible to make Roth IRA contributions, you can still make Roth 401(k) contributions. I plan to write more on Roth 401(k)’s in the very near future.
I can’t help myself. I’m going to illustrate the potential future value of a Roth IRA account, using my HP12C financial calculator. Here are the facts surrounding our example:
Name: Bernard Valeara
Age: 33
We will assume Bernard wants to start taking his Roth monies out in 30 years.
We will assume a $5000 annual contribution is made on the first day of each calendar year. Although this is the maximum contribution for 2008, it will be small in comparison to allowable future contributions.
Rate of Return: 8.5%
Drum roll please…
The future value of this account would be $673,864.89. Not too shabby.
In Conclusion
After reading this post, and the last, I think you’re up to date on all things Roth. It’s important to have a good working knowledge of the Roth IRA and you now have that… give yourself a pat on the back:)
Tags: required minimum distribution, RMD, Rule 72t, substantially equal periodic payments
clambelly | Jan 15, 2008 | Reply
Another interesting post. Looking at your quote below made me think of another topic that you may want to discuss at some point.
“The future value of this account would be $673,864.89. Not too shabby.”
The future dollar amount may be $673,864.89 but the future value cannot be determined. A couple of things come to mind. 1. its great to encourage by showing how much $5000-a-year can turn in to if invested properly, but dangerous if it leads to complancency based upon a false assumption that the value of that money will be anywhere near today’s value. 2. When discussing historic rates of return shouldn’t we back out historic rates of inflation to see a truer future value (and what are the historic inflation rates)? And 3., How should an average retirement investor protect himself against inflation or a global devaluation of the dollar?
Thanks. CB
CHM | Jan 15, 2008 | Reply
Clambelly good to see you around.
Been thinking about doing a future value of money post, will do and include a couple simple tips on how to do a few of the equations.
1- I don’t think you should ever be complacent. As far as this example is concerned, when it comes to the Roth IRA there’s not much more you can do other than contribute the max each year (for 30 years) and build/monitor your portfolio.
I’d suggest using the Roth as your starting point for a full on assault of planning your future.
2- When modeling financial plans, I have to plug in assumptions for returns on stocks, bonds, cash, antique coin collection, etc. I plug in an inflation assumption as well. i use 3.2%
3- If your risk profile is appropriate, I suggest building a portfolio that historically has outpaced inflation, a diversified equity based portfolio will do.
I don’t spend much time thinking about what’s happening with the dollar and letting things like that dictate long term retirement investment decisions. Don’t get me wrong I may tweak the overall allocation from time to time to accommodate something like that, but nothing drastic.
So to date, I’ve got Efficient Frontier and Time Value of Money from CB, puttin’em both in the idea bank.
Cheers,
C
clambelly | Jan 15, 2008 | Reply
Thanks. I’ll look forward to it. A couple of softballs but I hear a lot of people, already taking some of the steps you recommend, overestimating the true value of their nestegg at their projected retirement date. I absolutely agree with your main point, if you are eligible for Roth, max it out. The other stuff can be worried about later.
I just had another thought about what many of your target audience will probably face at retirement age: mortgage payments. How about an article on the role of home ownership as part of the retirement plan, and back to time value, how do you best balance funding your retirement fund with reducing your debt (ex. prepaying the mortgage). Thanks, CB.
CHM | Jan 16, 2008 | Reply
Hey CB,
Sorry for the late response, been swamped. I’ve got like 10 articles headlines I want to do, so I’ll keep your ideas in mind for future pieces.
The question of reducing your debt or funding retirement accounts is a toughie.
Ask 3 different people you’ll get three different answers. For good measure throw in establishing an emergency fund. Those are always the three horsemen in this debate.
It’s almost like a bad joke… the investment guy says contribute to the retirement accts., the debt guru says wipe away the debt (because the psychological benefits of doing so will motivate you in every other aspect of your life.) And ofcourse, how can you not have an emergency fund for those unexpected occurences, car breaks down, root canals:(
(Punchline please)
At the end of the day, I think the answer is a personal one and I think you touched on it in the question itself: balance