A Brief Guide to Roth IRAs

Individual Retirement Accounts (IRAs) are popular and there are multiple varieties: traditional, rollover, inherited, to name a few. Today I focus on the Roth IRA, which is unique in how it grows tax-free. As we age and move into retirement, distributions that affect income taxes can be a concern. Traditional IRAs and 401ks require you to distribute a taxable amount each year in retirement, which adds directly to your income tax liability. The higher your income tax liability, the more likely that your Social Security will be taxed and your Medicare Part B premium will be increased. Unlike traditional IRAs, withdrawals from Roth IRAs are tax free and thus don’t impact Social Security or Medicare premiums.

There are whole books written on Roth IRAs and the strategies associated therewith. My goal below is to just give you some basic facts that may intrigue you to ask more questions:

1. Unlike traditional IRAs that are funded with pre-tax amounts, Roth IRAs are funded with after-tax amounts and thereafter allowed to grow tax-free. Pay the tax now and fund a Roth IRA vs. delay the tax until later and fund a traditional IRA.
2. Unlike traditional IRAs, there are no required minimum distributions from Roth IRAs for the original owner. Beneficial owners after the death of the original owner do have a 10-year time limit to fully withdraw the funds from the Roth IRA but there’s no tax associated with the withdrawal.
3. There are contribution limits to a Roth IRA. First, you can only contribute an amount equal to or less than your earned income for the year. For 2025 the contribution limit is $7,000 if you’re under 50 and $8,000 if you’re over 50. There’s also a phaseout on your ability to contribute that begins at $150,000 for single filers and $236,000 for married couples filing jointly. For high earners there still may be ways to get around the income limits (see paragraph 5 below).
4. Employer Roth IRAs through a 401(k) plan are becoming more popular. If your employer offers one, the 2025 total employee and employer contribution limit is $70,000 and the employee portion is based on age: $23,500 if under 50, $31,000 if 50 or older, and (just to make things more complicated) there is also a “super” catch up rule for those age 60 to 63 that allows for a $34,250 employee contribution. All those limits are subject to the company 401k plan rules.
5. Outside of a traditional Roth or a 401(k) Roth, there is also the area of Roth conversions. Basically, it’s a process in which you take money that you contributed pre-tax to a traditional IRA and “convert” it to a Roth IRA after paying taxes on the amount converted. Subsets of the Roth IRA conversion have fancy names like the “Back Door Roth Conversion” and the “Mega Back Door Roth Conversion.” The concept is similar in that you are putting money into a traditional IRA or 401(k) and then converting it to a Roth. High earners can use these “back door” approaches to get around contribution limits.  There are several factors to consider in deciding if a Roth conversion is right for you. They include relative marginal income tax rates now and in the future, whether you are in your highest income earning years, and the amount you currently have in tax-deferred traditional IRAs. Since you must pay taxes on the conversion, the source of outside funds available to pay the taxes is also a factor. Note though you cannot make a Roth conversion with an IRA you inherited from someone else. It has to be your original traditional IRA.
6. There are limits to withdrawals from Roth IRAs and their complexity is beyond this weekly newsletter. Many people who look into Roths come across the five-year rule that says you will be penalized if you withdraw funds from the Roth IRA within five years of its creation. That rule is commonly misunderstood. The rule only applies to the growth in the Roth IRA. Your original contribution amount can be withdrawn at any time without a penalty or a tax. Note there are different rules for withdrawals from 401(k) Roths that aren’t so accommodating.

Roth IRAs have their place in an investment portfolio because of their tax-free nature and avoidance of required minimum distributions. However, there are many factors to weigh before determining if a Roth is right for you. The younger you are, the better the Roth option becomes. If you have a friend or loved one in their teens who has a basic job, a wonderful gift is to open a Roth IRA and contribute an amount that equals their wages for the year. Just think of the growth over decades tax-free.

Fun fact: I hope you’ve been following my beloved Pistons basketball team. They are in a playoff dogfight with the New York Knicks and growing into seasoned competitors. The Pistons have won 3 world championships: 1989, 1990 and 2004. They are slowly getting closer to their 4^th!

Financial Lessons From the Series The White Lotus

I suspect some of you have been intrigued by the HBO comedy/drama television series called The White Lotus. For those of you who haven’t watched it, it’s a series that follows the exploits of both guests and staff who spend a week at a global luxury resort chain called “The White Lotus”. Season 3 was filmed in Thailand and the cinematography was quite something. It’s basically a “who done it” with eccentric characters.

There is lots to digest every season, but the $5 million hush money payment in Season 3 was particularly interesting. In a nutshell, two of the characters in Season 3 were also in Season 2. One of them was a prime suspect in the murder of his wife and the other, while not a witness to the murder, was aware of the unusual circumstances surrounding the death. Suffice to say in Season 3 it becomes very obvious to the prime suspect, who has moved to Thailand to avoid investigation, that the person aware of his background knows who he is, what he did, and the fact that he is now hiding in Thailand and living the life of luxury (his deceased wife was wealthy).

In the end, the witness agrees to take $5 million to keep things quiet. She gives her account number and routing number to the suspect and, a few days later when she confirms that the $5 million has been wired to her account, she fades off into obscurity as part of the deal. Just for fun, let’s break down this $5 million hush money payment:

• Will this transaction be reported by the bank? Probably not, because the money was wired to the account instead of being deposited in cash. Banks are only required to report cash transactions exceeding $10,000 via a Currency Transaction Report to the IRS. This transaction would likely not be flagged by the bank.
• Is the transaction taxable? Yes, under a Supreme Court ruling in the 1950s, extortion payments are considered taxable income to the recipient. If this transaction occurred in real life the witness would have to report the proceeds as taxable income. This would not be considered a gift because legally a gift must be made clearly with donative intent and free of any expectation of anything in return. The witness’ silence is the quid pro quo here.
• Is the payment deductible? No. The suspect cannot consider this an ordinary and necessary business expense. This is a hush money payment under personal and non-business circumstances.

While the hush money payment in The White Lotus was purely fictional, it does raise some interesting questions that everyone needs to consider if they received a windfall, inheritance, intended gift, or in this case some kind of hush money payment. As for The White Lotus, I’m looking forward to Season 4. I’m told the setting might be Australia.

Fun Fact: For those of you intrigued by high-end luxury hotels, The Burj Al Arab in Dubai is the world’s first “seven-star hotel” i.e. the most luxurious hotel in the world. It includes a “pillow menu” with seventeen options, six high-end restaurants, a rooftop helipad, and a Rolls-Royce shuttle service from the airport. Each guest is given a 24-karat gold iPad upon arrival that is programmed to include access to all guest services and hotel information.

Don’t Put That 1040 Client Copy Tax Return Away Just Yet

I suspect that most of you have completed your 2024 taxes by now. Tax time is a hassle and most people have the urge to quickly file away the paperwork once their accountant tells them the taxes have been completed.

I think it’s a good idea to take a few minutes to go through the various schedules on the 1040 to confirm all of the assets and liabilities that make up your estate. You can use that review to make sure that you have your assets protected from probate. The 1040 is your opportunity to do an annual review of all of your assets and to update your annual asset list (You do have an asset list that you update annually, don’t you??).

Equally important is your opportunity to review the 1040 of a friend or loved one who is or will be relying upon you to handle their affairs after they pass on. Reviewing that person’s 1040 will allow you to have a snapshot of all their sources of income so that you can make sure they are properly protected from probate. You may find a bank account or a brokerage account that they’ve never talked about and maybe even forgot about.

Your 1040 is only about 2 pages long, but attached to it are various schedules that give details about income and liabilities. The four schedules listed below are important for confirming sources of income. Income comes from an asset and the asset has an owner which is probably the person whose 1040 you are reviewing. Upon death, that asset needs to be co-owned with someone else, held in a trust, or designated with a beneficiary. Otherwise, you risk probate at death. Here are the four schedules to look at carefully:

• Schedule B: “Interest and Ordinary Dividends”: This schedule applies if you have over $1,500 in taxable interest or ordinary income. It’s where bank accounts, CDs and stocks, bonds and mutual funds will be found. Make sure you match up each source of income so you know what you own. If you find a bank or stock that you didn’t know about, now is the time to dig deeper.

• Schedule D: “Capital Gains and Losses”: This schedule addresses transactions related to after-tax investments like brokerage accounts and individual stocks. Go through each entry and make sure you know how the asset is owned and whether it has a beneficiary or it could be subject to probate.

• Schedule E: “Supplemental Income and Loss”: This is where income or loss related to a probate estate, trust, rental real estate or other business arrangements are listed. This is a good place to figure out if someone is a beneficiary on a decedent’s trust or estate.

• Schedule 1: “Additional Income and Adjustments to Income” has two parts: Part One: This is where all sorts of “unique” income shows up, including unemployment, alimony, business income. Gambling winnings and prizes and awards also show up here. Part Two: This has adjustments to income and, for an elderly loved one, check to see if there was any penalty on early withdrawal of savings (e.g. cashing a CD in before maturity). This could be a tipoff that the person doesn’t fully understand the ramifications of their transactions.

Before you file your 1040 away, take a minute to use this as a checklist for assets.

Fun fact: Easter is upon us. When it comes to the largest Easter Egg, the record was set in 2011 in Italy where an Easter Egg measuring 34’ 1.05” was crowned the largest ever chocolate egg at the Le Acciaierie Shopping Centre. The chocolate egg weighed 15,873lbs and had a circumference of 64’ 3.65” at its widest point.