IMG Wealth Management
Financial Planner, Analyst
Nathan Edwards is a CERTIFIED FINANCIAL PLANNER™ professional and CFA charterholder. He is committed to the idea that establishing clearly defined financial objectives is the keystone of the financial planning process. With these objectives as the foundation for a viable financial plan, Nathan believes that it is possible to elevate one's peace of mind and financial well-being both now and into the future.
IMG Wealth Management was created by professionals from Investment Management Group in 2017 to meet the specific needs of high net-worth individuals and institutions. Nathan and IMG Wealth Management's team of financial planners, investment managers, and support staff have developed a business model tailored to the unique requirements of their core clientele.
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There are several varieties of risk that could be associated with a Roth IRA. If we’re starting from scratch, this requires some explanation.
The “IRA” portion of a Roth IRA is an acronym that stands for Individual Retirement Arrangement. Straight from the IRS, “An individual retirement arrangement (IRA) is a tax-favored personal savings arrangement, which allows you to set aside money for retirement.”
This is significant because the qualities of the “arrangement” itself are dictated by its terms. In the case of the Roth Individual Retirement Arrangement, the terms prescribe that annual contributions can be made on an after-tax basis up to specified dollar limits according to specified annual income thresholds to accounts established with entities approved by the IRS to act as trustees or custodians of IRAs. The terms also dictate that any contributions made can be withdrawn at any time without creating a taxable event. However, earnings on contributions must remain in the account until the latter of the owner having a Roth IRA open for five years and the account owner’s achievement of age 59 ½ to avoid paying taxes and a 10% penalty on the distribution of earnings. Once the latter of these events has occurred, earnings can be distributed from the account tax-free.
The terms of the Roth Individual Retirement Arrangement also dictate what types of investments can be made within the account. Approved and disapproved investments within IRAs are listed by the IRS here. With this information, we can see that the Roth IRA itself is not an interest-bearing type of investment or account, but that the types of investments made within the Roth IRA will govern the investment returns and risks associated with the Roth IRA.
So, if the question is “What are the investment risks associated with a Roth IRA?” the answer will depend on the types of investments made within a particular Roth IRA. Given the wide range of investments available to be made within a Roth IRA, one can usually establish an investment allocation within their Roth IRA to reflect their personal investment risk tolerances.
As far as some other risks that are associated with a Roth IRA, a few might, arguably, include opportunity cost, tax risk, and liquidity risk.
The opportunity cost of a Roth IRA could be appraised against literally anything else one could do with their assets other than contributing them to a Roth IRA. For our present purpose, though, we’ll stick to the opportunity cost of contributing to a Roth IRA instead of a Traditional IRA. Because, as of 2017, a total of $5,500 ($6,500 for those over age 50) can be allocated between one’s Traditional and Roth IRAs, contributing one dollar to a Roth IRA means that one less dollar can be contributed to a Traditional IRA. Because of the different tax treatments of these two types of IRAs, this limitation could be meaningful to some. Which leads to the next risk associated with a Roth IRA, tax risk.
Because Roth IRA contributions are made on an after-tax basis, and can eventually be distributed tax-free – if it is a qualified distribution – the Roth IRA can possess advantages over pre-tax contributions to accounts like a Traditional IRA if one’s taxes are lower when the contributions are made, and higher when distributions are taken. Tax rates, and even retirement income, can be tricky to forecast into the future. This being the case, those that contribute to a Roth IRA run the risk of their tax rate being lower upon eventual qualified distributions from the account than when contributions were made; potentially making those contributions less tax advantageous in hindsight if one had the ability to contribute on a pre-tax basis when the contributions to the Roth IRA were made.
We covered that there are stipulations about when tax-free distributions of the earnings within a Roth IRA can be made. Until certain conditions are met - namely, the latter of having a Roth IRA for 5 years and the owner of the Roth IRA achieving age 59 ½ - earnings within a Roth IRA would be subject to taxation and a 10% penalty. These stipulations make distributions of the earnings from this account less desirable during certain periods of time. This raises questions of liquidity in terms of barriers to access to the assets within a Roth IRA, which is a type of risk.
While risks to establishing a Roth IRA exist, they should be weighed against any potential benefits within the context of the potential owner’s personal financial situation.
If you fall within the parameters the IRS has outlined here, you might be able to have your cake and eat it, too, so to speak! Generally, you can convert your primary residence into a rental property and avoid paying taxes on some or all of the capital gains upon its eventual sale. That is, as long as you owned and lived in the property as your “main home” for two of the five years prior to the date of sale.
A big sticking point, and potential risk, is a matter of timing. Yes, you have to have occupied the home as your primary residence for at least two of the last five years. That’s usually the easy part. The hard part is the clock that starts ticking once you move out. If you resided at the property continuously for at least two years prior to moving, then you’ve got three years to sell it.
It sounds easy on paper, but, as we saw during the most recent financial crisis, buyers do not always materialize when they are needed. The timeline factor becomes an even more important consideration if the plan is to rent the property for a couple of years prior to putting it on the market.
Considering what’s at stake, it is certainly advisable to speak with a tax professional – and probably a disinterested realtor – that is familiar with your specific situation prior to making any decisions.
As ridiculous as it sounds, if you want to work for a particular employer, you might have to enroll in one of the retirement plans offered by the employer. I found one example of this requirement at a local university. While an employer might have the ability to force your enrollment into a retirement plan, no one has the ability to force you to become – or at least stay – employed by a given employer. So, if, for whatever reason, you are opposed to retirement plans offered by an employer, and that employer has the ability to force your enrollment, your options may be to enroll or find new employment.
That being said, many retirement plans do offer attractive opportunities. While it is understandable to be a little hesitant to hitch one’s wagon to a public or private organization’s defined benefit plan if that plan is severely underfunded, there are still many well-funded defined benefit plans around that offer a light at the end of the employment tunnel. The best of which would be hard to pass up, as you might potentially be losing something and gaining nothing to not elect enrollment. This decision could only be made on a person by person, and plan by plan basis, though.
As for defined contribution plans, if the employer is making non-elective contributions on your behalf, and/or matching your elective deferrals, it would be more difficult to create an argument against participation than for participation. Again, the ultimate decision to participate or not should only be made on a person by person, and plan by plan basis.
If this is a concern for you, you will want to ask about a prospective employer’s retirement plans – and your ability to choose whether or not you want to participate – prior to employment. If you’re already employed, then you definitely want to request all of the information that you can get your hands on about the retirement plans available to you through your employer.
Occasionally, if an employer offers multiple plans, the choice to enroll in any of the plans is mutually exclusive. If you enroll in one, you might lose the opportunity to enroll in one or all of the others.
Because a tremendous amount of money could be on the line, these are not decisions to be taken lightly. Get the information you need, and make sure you do the math.
It looks like there are a couple of different questions here, so I’ll try to address them all.
If you’re asking if a catch-up provision applies to Traditional IRA and Roth IRA contribution limits over age 50, the answer is, yes. Unfortunately, the catch-up for IRAs is only an additional $1,000 (as of 2017), which is not nearly as stout as the $6,000 (as of 2017) 401k catch-up provision.
If you’re asking if you can contribute to – and receive the tax benefits of – an IRA even though you have already contributed $18,000 to your 401k, the answer is, it depends. It should be said, however, that the answer doesn’t depend on the amount you contributed to your plan at work, it depends on how much income you will earn in a given year. Contributing to a 401k doesn’t affect your ability to contribute to an IRA, but having access to a 401k, and the amount of income that you earn might.
Because you’re covered by a retirement plan at work, you can contribute to and fully deduct contributions to a Traditional IRA if your Modified Adjusted Gross Income (MAGI) is $61,000 or less (as of 2017) if you file your taxes as “single” or “head of household.” If you file “married filing jointly,” you can contribute to and fully deduct contributions if your household MAGI is $99,000 or less (as of 2017). If your MAGI is higher than either of these thresholds, but less than $72,000 (filing single) or $119,000 (married filing jointly) you will still be able to partially deduct your contributions to a Traditional IRA.
If you (or your spouse, if applicable) were not covered by a retirement plan at work, there would not be an income limit to the deductibility of your Traditional IRA contributions; although, deductible contributions would still be capped at $6,500 (for 2017) for someone over age 50.
If, instead, you are interested in contributing to a Roth IRA, you can make a full over age 50 contribution in 2017 of $6,500 ($5,500 contribution limit + $1,000 over age 50 catch-up contribution) if your MAGI is less than $118,000 and you file your taxes “single” or “head of household.” If you file “married filing jointly” you can make the full over age 50 contribution if your household MAGI in 2017 is less than $186,000. If your MAGI is higher than either of these thresholds, but less than $133,000 (filing single) or $196,000 (married filing jointly) you will still be able to make a partial contribution to your Roth IRA.
It sounds like you’re leaving the employer through whom you contributed to your 401k. If you haven’t left yet, or if you left after age 55, your 401k might be valuable to you for a couple of years if you plan on taking distributions form your investments.
While some others might recommend rolling over your 401k, I encourage you to read this article – Older Than 55 and Younger Than 59 ½? Be Careful Rolling Over That 401k – before you take that step. Basically, the article outlines the potential benefits of keeping assets inside your old employer’s 401k plan if you retired after 55, but need to start taking distributions prior to age 59 ½. The long and short of it is, you might be able to take distributions from your 401k without incurring the pre-59 ½ 10% penalty that would be imposed on an IRA.
As far as the recurring payments part of your question, the frequency of allowable distributions will likely depend on the stipulations of your 401k plan, and/or those of the custodian.
With regard to the amount and form of payments, you are going to have to do some math, or get in touch with a financial planner to help you figure out a sustainable distribution rate. It would be great if I could say “Go put your money in investment X, pay yourself Y, and you’ll be good to go!” But the truth is, distribution planning is highly personal. General advice will not do, and don’t let anyone convince you otherwise. What is appropriate for someone else might decimate your retirement savings and/or duration.
What you need to figure out is what your expenses will be in retirement – preferably from both a discretionary (want to spend) and non-discretionary (have to spend) standpoint – across the time period that you intend to be retired. From here you can subtract any expected recurring income. These are things like defined benefit pensions, Social Security retirement benefits, and any employment income. If your recurring income covers your expenses, then, hopefully, you won’t have to distribute any additional income from your retirement accounts (until the government makes you at age 70 ½, anyway). If your recurring income doesn’t cover your expenses, then you can back into the periodic distributions necessary to make up the difference during a specified period (week, month, year, etc.)
At this point it starts to get tricky. Because of inflation, and potentially your changing circumstances, we shouldn’t just look at one period, or the first several periods, and choose a recurring rate of distribution. The distribution for one period might not be enough, or might be too much, for another period.
The required periodic distributions for future periods, based on expected inflation adjusted expenses, expected inflation adjusted recurring income, and expected assets available for distribution include a lot of “expectations.” In other words, determining if you have enough to sustainably distribute the income you need to maintain your desired quality of life in retirement is based on a fair amount of forecasting. This forecasting necessitates assumptions for inflation, cost of living adjustments to recurring income, and assumed periodic rates of return (and variance) on invested assets, among other assumptions.
This is what so many folks understand too late in the process. If any of these assumptions are off, one runs the risk of paying themselves less than they could have in retirement, or paying themselves too much in the early years and running out of investment and savings assets earlier than anticipated. For many people, the risk of greater concern is the latter.
It is not impossible for you to suss this out on your own, but the stakes are very high. It will not be possible for someone, even a competent professional, to provide you with the type of advice that you’re seeking without having a thorough grasp on your individual financial circumstances, as well as your financial objectives. Okay, it’s possible, but that doesn’t mean that advice provided without the necessary information would be worth acting upon.