TEXT OF INTERVIEW
Tess Vigeland: You’ve heard us say over and over on this show that one of the best retirement savings options is the Roth IRA. All kinds of reasons for that, which we’ll reiterate in a moment. But these days the Roth is engendering all kinds of questions, because the rules around it are changing.
And so to help clear up some of the confusion, we’ve brought back Stuart Ritter. He’s a vice president and financial planner with T. Rowe Price.
Stuart, welcome back.
Stuart Ritter: Glad to be here.
Vigeland: So let’s go very basic here. Let’s start out with a definition what a Roth IRA is.
Ritter: A Roth IRA is a way the government let’s you save for retirement and not have to pay taxes when you take the money out of the account. Now if you put it in a taxable account, every year you get one of those 1099 forms that says you earned this much, give some of it to the government.
Ritter: If it’s in the Roth account, you don’t get that form. And ultimately, when you take the money out of the Roth IRA, you don’t pay taxes on the earnings, as long as you meet certain criteria.
Vigeland: But there are limits to who can have a Roth, correct?
Ritter: There are income limits. If you earn too much money, the government will not allow you to put money into a Roth, to contribute to a Roth IRA account.
Vigeland: Then, what is this conversion that we are all hearing about now?
Ritter: Converting to a Roth IRA means that you already have money in a traditional IRA and you take the money out of the traditional IRA and you put it into a Roth IRA. Now when you do that, it’s considered a withdrawal from your traditional IRA, so you have to pay taxes now on the money you take out of your traditional IRA. So the trade off is, you pay taxes today — when you do the conversion — and that means you don’t have pay taxes on any future growth on that money, because you moved it to a Roth IRA.
Vigeland: So you say that you pay taxes on the conversion, I assume, even though you’re making an early withdrawal from your IRA there’s no penalty?
Ritter: Not if you’re converting it. It is one of the exceptions to the penalty.
Ritter: Now one of the things to be careful of — and now we’re going to get into the theme that I think that’s going to be carrying throughout the rest of our conversation.
Vigeland: Which would be a confusion?
Ritter: Yes! Unfortunately. I’m going to call it a “complexity,” but they tend to go hand in hand.
There are a lot of things associated with this conversion that you really, really need to talk to a tax advisor about. For example, if you open a traditional IRA at the end of 2009, put money in there. Well, if you have another traditional IRA, sitting over somewhere on the side, the IRS doesn’t allow you to just pick the $5,000 you just opened a new traditional IRA with and move that. They want you to look at the whole thing and the amount that you convert to the Roth IRA, some of it may now be taxable. Again, there’s a lot of complexity with this. When it comes to your company’s 401(k) match, that’s a no brainer: go get the match.
When it comes to converting to the Roth, it can be advantageous for a lot of people, but it is something you’re going to have to spend more time investigating and analyzing.
Vigeland: Is there a general rule of thumb of who this benefits?
Ritter: One of the things you can think about is, the longer it is until you plan to use this money, the more beneficial converting is going to be. So if you are 70 years old, and this is money you were probably going to use up before 80, you’re going to withdraw it, probably doesn’t make sense to convert it. If you are 25 years old, and you’ve got a couple thousand dollars in a traditional IRA, and it’s going to be decades before you use this money, it probably does make sense for you to convert it.
Vigeland: And again, that’s because the earnings are then not subject to tax.
Vigeland: All right Stuart. I’m sure I’ve forgotten many questions that people will have and I’m sure they will write in and when they do, don’t be surprised if we call you back.
Ritter: I look forward to it.
Vigeland: Stuart Ritter is an assistant vice president of T. Rowe Price Investment Services. He’s also a financial planner with T. Rowe Price. Thanks as always for coming in.
Ritter: Good to be here.
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