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Investing in a Roth IRA: Another Look!
from: John GrothTax Savings with a Roth IRA: Both Short and Long Term if handled correctly can be a big boost to retirement income and income flexibility-all the time saving big on income taxes.
Mike was off work for three months in 2007, now he’s got a better job and he needs tax help. On what question does Mike need tax help? Well, sitting in an account at his former employer is his 401k account, including his employer’s match. The last time Mike looked the account held about $12,000.
Mike is 35 and plans to work until age 65 or beyond. So the money in the account will grow and compound for at least 30 years. Mike’s dilemma is what he should do with the 401k account to minimize his tax burden.
Mike was off work for three months in 2007 so his taxable income will be lower this year. Next year his overall income will be at least 30% more than in 2007. His adjusted gross income in 2007 will be less than $100,000.
He could roll the money over to a conventional IRA and his tax situation regarding the 401k account would remain the same. However, after age 59 ½ any fund withdrawn from the IRA would be subject to tax based on his taxable income at the time. In addition, at age 70 ½ he would be forced to withdraw a set amount from the IRA based on various factors. Since Mike was an aggressive saver and investor and he anticipated his income after retirement to be greater than when he was working.
One option is to leave the funds with his former employer. He rejected this idea as he wanted more control of the funds.
Next he looked at rolling the funds into a Roth IRA. It had one disadvantage in that the money would be taxable income in 2007. However, the money would grow tax free and after age 59 ½ anything he withdrew from the Roth IRA would be free of tax. In addition, there was not requirement that he begin withdrawing funds at age 70 ½. Mike liked this idea as it would give him more flexibility with the funds.
He calculated by taking in the $12,000 as income in 2007 his tax bill would go up about $1500. By estimating his total income tax for 2007 without the $12,000 he would have about a $700 refund coming. So by paying an additional $500 in taxes for 2007 he could get the advantages of the Roth IRA. Mike estimated, he could earn about 8% on the $12,000 and over 30 years the fund would grow to more that $120,750.
For 2007 Mike had to roll the 401k into a conventional IRA and then move the funds into a Roth IRA. For next year the conventional IRA step will not be required and the $100,000 adjusted gross income limit stays the same at $100,000.
All together Mike believes he has come up with an elegant solution to his rollover situation. Further, he turned the three months off work in 2007 into an opportunity to save a significant amount of taxes when he’s ready after age 59 ½ to withdraw money from his Roth IRA account.
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