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028 | Order of Operations | The Buckets | The Roth IRA

In today’s podcast we discuss the four different “buckets” available to savers plus an in-depth look at the Roth IRA and the ‘Backdoor Roth.’

Podcast Episode Summary

  • The order of operations for how you should approach the different “buckets” available to you both for retirement accounts and for your taxable savings
  • Four basic ways for your retirement and investment funds to be taxed
  • Best case is an account similar to the HSA which is not taxed when you put the money in nor when you pull it out
  • Option 2 is the Roth IRA which is taxed upfront but not when you pull the money out
  • Option 3 is a traditional IRA, 401k, etc. where it is not taxed when you contribute but is taxed when you withdraw
  • Option 4 is your regular savings/investment accounts
  • We focus mostly on tax-deferred retirement accounts because that is the best way to lower your taxable income in the current year and reduce your tax liability. Because of advanced FI concepts such as the ‘Roth IRA conversion ladder’ there is a chance you can pull this money out nearly tax free once you reach financial independence
  • You want to max out your tax-deferred options
  • The FI community looks at this problem differently than traditional financial planners and doesn’t focus on the Roth IRA generally
  • Roth IRA makes sense if you are nearly certain that your tax rate will be higher in retirement than it currently is now (think children under 18)
  • The issue is this is unknowable at the time of contribution (unless you are at a 0% rate)
  • You can pull out your Roth IRA contributions at any time tax and penalty free
  • Flexibility of your bucket #4 (taxable savings) is a big positive of that investing option over a Roth IRA
  • The concept of a marginal tax bracket and an understanding of how your income is taxed
  • Financial planners focus on the ‘tax diversity’ play of the Roth versus traditional retirement accounts
  • Income limitations do exist for the Roth IRA
  • There are also contribution limitations yearly for these accounts
  • How to reduce your Adjusted Gross Income on your tax return to qualify for a Roth IRA
  • The Backdoor Roth IRA option for high income individuals
  • Discussion of the White Coat Investor article on the Backdoor Roth IRA and how you can convert your money from a nondeductible traditional IRA to a Roth IRA (the ‘backdoor’ Roth)
  • Avoiding the pro-rata calculation
  • How to contribute to the traditional IRA account as a nondeductible contribution and then convert it to a Roth
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