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Want surprisingly flexible savings options? The ONE account that can help

A lot of us want flexible savings options, right? We don’t want all our money locked away till we’re 60, we don’t want to worry about withdrawal limits, and we don’t want to have to make a case that our life sucks just to take money out of an account that’s OURS just because we haven’t reached a certain age yet.

But we do know that we want to save for the future, we’re just not sure exactly WHAT in the future we are saving for. And all those money modules and financial planning processes start with wanting to know what your goal is.

This is a common roadblock for my clients - choosing a financial goal feels restrictive and like we’re getting ahead of ourselves. What if you don’t have one right now? Or you have a bunch and you’re not sure which is most important? Maybe you don’t know what you’re specifically saving for or exactly how much it should be or when you’ll need it, but you DO know you want to do SOMETHING besides just let it sit in your savings account.

What if you just know that you don’t want to wait any longer to start saving in a more growth-oriented way?

What if your goal is just to optimize your money but you want to keep your future options open as much as possible?

Now, it’s called personal finance for a reason. Because it’s PERSONAL. Which means that what I’m about to share doesn’t mean it’s for everyone, but when I get to talking with people who:

A: Know that they want to start investing for the future and understand that doing so will put their money at risk of short-term fluctuations in value and

B: Don’t really have a specific goal in mind but know that they probably won’t need the money they’re going to invest for at least several years, if not decades and

C: They also have conflicting things they might need money for in the future AND

D: It freaks them out a little bit to think about putting their money into an account for retirement ONLY, but they do want to be saving for retirement in some way

Then my suggestion is almost always a Roth IRA. (I go much deeper into this on episode 8 of my podcast!)

Why do I think the Roth IRA is so great for flexible savings?

When you put money into a Roth IRA through a direct contribution you can withdraw that money back out WHENEVER you need it. But it’s those special rules for Roth IRAs that make it such an attractive place to get started saving for the future. While the Roth IRAs primary purpose is to save for retirement, if you end up needing it for other life goals in the future, the potential tax consequences and penalties are a lot less or non-existent when compared to other types of retirement accounts like 401ks and traditional IRAs.

I think most people know that Roth IRAs have two limits, but let’s review just to be sure.

Roth IRA limit #1: the contribution limit

This is the limit on the amount you can deposit into the account with new dollars each year. For 2023, that limit is $6,500 for people under age 50 and $7,500 if you’re 50 or older.

Roth IRA limit #2: the income limit

Once your income is over this limit, the IRS says you’re not allowed to make direct deposits, or contributions, to a Roth IRA.

First, remember that this is the Roth IRA, not the Roth 401k, which doesn’t have income limits. But in 2023, if you’re filing as a single taxpayer, the ability to contribute directly to a Roth IRA starts to phase out once your income hits $138,000 and phases out completely once you get to $153,000. At that point, you can’t make direct contributions to a Roth IRA for that tax year.

For married people filing jointly, that phase-out is between $218,000 and $228,000. This means that if you and your spouse’s combined modified adjusted gross income is over that limit, you can’t make contributions to a Roth IRA.

What if you earn too much to use a Roth IRA?

First of all, if you know for sure that you out-earn the limits, then as of the publishing of this post, the “Backdoor Roth IRA” is available to you, you just need to beware of the pro rata rules. For more on the specifics of that, check out this post.

But if you’re on the cusp or your salary exceeds the limits but not by much, you may not ACTUALLY exceed the limits. That’s because it’s not your gross income that the rules look at, it’s your modified adjusted gross income. Modified adjusted gross income is all the income you earn MINUS certain deductions. Those deductions include:

  • pre-tax 401k contributions

  • any health insurance premiums you pay out of your paycheck

  • any health insurance premiums you pay as a self-employed person

  • HSA contributions

  • student loan interest (as long as it’s deductible, which it may not be if your income is close to the Roth IRA contribution limits)

  • For my teachers: That piddly little $300 deduction you can take for supplies you purchase for your classroom

  • Others, depending on the tax year and what Congress wants to play with at the time… (snark)

So let’s say you’re married and your combined salaries and other income is, say $240,000. But you put the maximum of $7,750 into your HSA plus you’re both contributing 10% to your pre-tax 401k at work. With those contributions, your modified adjusted gross income will be less than $210,000. So you’d still be eligible to make contributions to a Roth IRA, even though your salaries and other income are actually higher than the limit.

What happens when you contribute to your Roth IRA?

Now, when you contribute to a Roth IRA, you’ll get a tax form (called Form 5498) from the financial institution that holds the account, typically after you’ve filed your taxes and usually it’s just an email saying the form is available. No biggie, since you don’t deduct your Roth IRA contributions on your tax return.

However, it’s a good idea to hang on to copies of this form as proof of what’s often referred to as your “basis,” or your original contribution amount.

tax form 5498
Form 5498

That’s because one of the cool rules about Roth IRAs is that when you withdraw the money in the future, as long as it’s deemed a qualified withdrawal, you won’t pay taxes on any of it. You won’t pay taxes on it even if the original amount has doubled or tripled or more! The only other place this is possible is with an HSA. Here’s an example:

Let’s say you’re 40 and you put $6,500 a year into your Roth IRA from now until you’re 60. Over the course of those 20 years you’d put in a total of $130,000. Now assuming that the stock market does what it’s traditionally done and returns ON AVERAGE about 10% over those 20 years, at age 60 your account could be worth over $370,000, which is almost triple. This means that when you’re 60, if you wanted to buy a house or a boat or whatever for $370,000, you could just blow up that Roth IRA and pay cash without paying ANY taxes.

BUT you would need to be over age 59 ½ AND your Roth IRA would have to be at least 5 years old before you could do that. HOWEVER, you can still access the money you put IN to your account at any time, as long as it was deposited as a direct contribution.

That’s right: You can withdraw your Roth IRA contributions at any time, without penalties or taxes Since you didn’t get any tax benefit for putting the money IN, you can actually take it back out if you want, no restrictions. This is why you need to hang on to those 5498 forms though, just in case the IRS comes asking.

Important caveat: The ability to take out contributions without penalty or taxes only applies to money you put DIRECTLY IN to the Roth IRA. Otherwise there is a 5-year waiting period before your withdrawal would not be subjected to a 10% early withdrawal penalty.

For example, if your income exceeds the Roth IRA contributions limits and you use the back door Roth IRA strategy to get your money in there, then the 5-year rule applies. The same goes for any conversion of funds from a regular or traditional IRA or 401k – you have to wait 5 years after you perform that conversion to withdraw the amount that you converted, even though you paid taxes on it at the time of the conversion.

This is especially confusing because there’s another Roth IRA 5-year rule. This other rule says that in order to make qualified withdrawals from a Roth IRA (withdrawing any growth without having to pay taxes or penalties), you have to have had a Roth for at least 5 years prior. A lot of people get confused about this and think that you have to wait 5 years to take ANYTHING out, but it’s just the growth – money that was directly contributed can come out 5 DAYS after the account is opened if necessary.

So using a Roth IRA is like saving for retirement but with a safe out SHOULD YOU NEED IT. No long-term commitment required! This little piece of information is often the only thing people need to overcome their resistance to putting money into a retirement-themed account. Want someone to hold your hand through this process? Or just some outer accountability to start taking action? I’ve got a handful of openings for 1:1 clients!

Disclaimer: The content of this post is for informational purposes and is intended to be educational only. It does not cover every possible nuance and is general in nature, and should not be relied upon as individual tax or investment advice. For a personalized evaluation of whether this makes sense to you or how to perform the transaction correctly, it’s best to work with a paid professional who can guide you within your personal circumstances.


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