Leyder "Aiden" Murillo, MBA
7 Facts Why a Roth IRA Is Vital for Educators + Free Flowchart Included
Updated: Apr 7
The link to our FREE Roth IRA contribution flow chart is at the end of the article!
We like to remind our clients that having many options is better than having none and finding yourself in a corner. The Roth IRA is not your typical retirement account, but it is an excellent addition to your retirement plan. The Roth IRA provides a great option in addition to your current 403(b) and/or 457(b).
As funding for retirement is a significant concern for many people, especially many of our clients who are educators, once you realize the benefits of a Roth IRA, you will like to get started with one quickly. Like any retirement fund, you want to start as early as possible because trying to catch up late is like arriving late to your party while your guests have already enjoyed the festivities.
What is a Roth IRA?
A Roth IRA is like a traditional IRA but has a couple of essential distinctions.
First, the similarities between a traditional IRA and a Roth IRA are:
As of 2023, you can make an annual contribution of $6,500 per year, or if your age is 50 or older, you can use the Catch-Up provision and contribute $7,500 per year
You can begin taking withdrawals without being subject to an early withdrawal penalty of 10%, starting at the age of 59 ½
Both a traditional and Roth IRA you can open at any brokerage firm and manage yourself, or an investment professional can manage it for you
Both allow the capability to add diversification to your overall retirement strategy as both accounts allow access to an array of different investments, such as alternatives or other assets not available in your 403(b) and/or 457(b)
The significant differences between traditional & Roth IRAs:
Contributions into a Roth IRA are unfortunately not tax-deductible
Withdrawals from a Roth IRA are tax-free as long as you meet the following requirements:
You are at least 59 ½ years old
The Roth IRA account is open for at least five years
The Roth IRA is the only retirement account not subject to the required minimum distribution (RMD) requirement that retirement accounts have. The RMD requirement is an IRS requirement that states that you must start to take distributions from the account beginning at the age of 73
You may withdraw early and may not be subject to income tax and/or a 10% early withdrawal penalty (more on this below)
Can you contribute to a Roth IRA?
The answer is it depends, but most like yes, the Roth IRA phases out after reaching certain income thresholds.
The income thresholds as of 2023 are:
If you are married and filing jointly, and your Modified Adjusted Gross Income (MAGI) is:
$228,000 or more – you cannot contribute to Roth IRA
$218,000 or more, but less than $228,000 – you may make a partial contribution to Roth IRA
Less than $218,000 – you can make a full contribution
If you are single and your MAGI is:
$153,000 or more – you cannot contribute to Roth IRA
$138,000 or more, but less than $153,00 – you may make a partial contribution to Roth IRA
Less than $138,000 – you can make a full contribution
Now that we covered the definition and eligibility for a Roth IRA, here are the 7 facts about why a Roth IRA is vital for an educator's overall retirement plan.
1. Create an Additional Savings Bucket for Early Retirement
As educators, you play a crucial role in developing society's future. It is a fulfilling profession. Perhaps you began as a teacher's aide, then a teacher, followed by a coordinator, and then made the big jump to an administrator (principal/vice-principal) or work in the school district office. Perhaps you took the route of being a professor and have publications with some residuals from your publications.
It is an arduous journey, and you don't want to do it for many years. However, the decisions you make now in your financial life are crucial to how you want to live your life in retirement. An educator's pension or retirement account and Social Security may not be enough to cut it during retirement. If you can learn anything from these last few years, the world throws unpredictable things: pandemics to high-flying inflation. High inflation is a considerable risk for retired people living off a fixed income. By having an additional "savings bucket," you provide another account to tap into. Remember, more options are better than less, or worst, having none.
With the recent passage of Secure Act 2.0 (SECURE 2.0), beginning in 2024 any unused funds in a 529 plan can be rolled over into a Roth IRA, therefore, returning funds to the 529 plan owners for retirement purposes. This helps with a parent's biggest concern about overfunding a 529 plan. For example, if the child gets a scholarship, school expenses less keeping funds some funds unused, or if the child chooses not to go to into higher education after secondary school.
There are limitations though: the transfer is subject to the beneficiary's annual contribution limit and up to the lifetime maximum of $35,000. Also, the 529 plan needs to be open for 15 years or longer.
When it comes to your overall retirement plan, you want to start early. The earlier you begin, the power of compounding interest will work its magic for you. It's all math, and guess what we learned about this subject of compounding interest in school from educators.
2. Create Tax-Free Income During Retirement
One of the benefits of a Roth IRA is the withdrawals from the account are tax-free once you are 59 ½ and keep the account open for at least five years. Having a Roth IRA provides one retirement income source that is tax-free. Who doesn't like tax-free income?
If you participate in a 403(b) and/or 475(b) while also perhaps receiving an educator's pension and Social Security, it may push you into a higher tax bracket. It may cause you to be in a higher tax bracket than where you are now.
A Roth IRA provides retirement income that will not affect your tax liability. If anything, it offers tax-free income if you do move into a higher tax bracket because of your retirement distribution. To ease being pushed into a higher tax bracket, at minimum, you need to take the required minimum distributions (RMDs) of your 403(b) and/or 457(b). A Roth IRA may provide the flexibility to cover your retirement expenses while taking the minimum RMDs.
3. Adds More Diversification to Your Investments
A 403(b) and 457(b) lack the robustness of investment options. One of the most common themes we see with our educator clients is that retirement plans offer limited investment options. To take it further, many of these 403(b) and 457(b) retirement plans are from insurance companies. As a result, the investment options limit you to insurance annuities or target-date funds with high investment fees. Although some plans offer some mutual funds or exchange-traded funds (ETFs) but the list is small, and the former may have high load fees.
A Roth IRA breaks away from the limited list of investment options as you have complete control to manage the account yourself or have an investment professional handle it. Almost all brokerage firms offer the option to open a Roth IRA and offer unlimited investment choices (stocks, bonds, alternatives, etc).
4. More Control Over Your Money
Like most employer-sponsored retirement plans, there is little control over them (see the previous point). Although having a 403(b) or 457(b) is a great way to have a long-term savings strategy. Surprisingly, people's most valuable assets are their home (if you own one) and their retirement plan, which means that most wealth (money) is in these assets.
Most employer-based plans limit your access to funds, but some give you access to take loans against your retirement money. When you take a loan out of your retirement account, you are essentially paying yourself at a fixed interest rate, but there may be some origination fees that go to the plan administrator and are not paid to you.
Consider the following situations: you want to buy a home and would like to increase your down payment, need to pay unexpected bills, need additional funds for putting a child through college, or you, unfortunately, become disabled and need money to cover medical bills. A Roth IRA provides an extra emergency fund (you should have one already). In addition, the uniqueness of a Roth IRA allows you for an early distribution penalty-free (more on this in the next point).
Having a Roth IRA gives you the freedom and flexibility to access your funds and not deal with the paperwork for a loan or asking for a hardship withdrawal from a retirement plan administrator.
5. Early Distributions Penalty-Free Emergency Fund
As mentioned in the previous point, the Roth IRA is unique and allows you an early distribution penalty-free. Therefore, you may withdraw early and not be subject to income tax and/or a 10% early withdrawal penalty.
For a qualified early distribution, there are two requirements. The first requirement is the Roth IRA account is open for more than five years. The others are you have an exemption from taxes and penalties if you become disabled when the distribution occurs. The other is if you use the distribution towards purchasing, building, or rebuilding a first home. If used for a home, there is a limit of $10,000 per lifetime.
The other early distribution is based on your contributions. According to the IRS Roth IRA order rules, distributions of regular contributions are always tax-free and penalty-free. Meaning when you make a withdrawal, the first funds that are taken out are your contributions.
For example, let's say you have $30,000 in a Roth IRA. Within the Roth IRA, $20,000 is your contributed amount, and the other $10,000 is investment earnings. You decide to withdraw $18,000. Since $18,000 is less than $20,000 from contributions, these withdrawals do not create any tax situation or penalty. The Roth IRA is the unique retirement savings account that allows for this type of withdrawal.
Consider now that if you want to withdraw an additional $5,000 later, from this, $2,000 is tax and penalty-free, while $3,000 would be subject to taxes. Also, if you have not reached 59 ½, you will be subject to early penalties and taxes.
Taking early distributions like in this scenario is not something you would like to think of as a standard distribution strategy that should be a last resort – an emergency fund. But remember, the more options you have, the better.
Always talk to your tax professional if you do this type of emergency distribution.
6. No Required Minimum Distributions
You can't keep retirement plans in the state of tax-deferred forever. Eventually, you will need to take the required minimum distributions (RMDs). As of 2023, the RMD age is 73, meaning you must take distribution even if you do not need the money. The Roth IRA is the only retirement account not subject to RMDs.
The RMD amount is based on a Uniform Lifetime Table from the IRS and uses your remaining life expectancy, which means as you age, the RMD increases. Having a Roth IRA allows you to have at least one account within your retirement plan that is tax-sheltered and not subject to RMDs. You can continue to draw down within the other retirement accounts.
7. Tax-Free Generational Wealth
The Roth IRA allows you to leave something to your heirs based on your estate planning goals and help transfer generational wealth. Like all retirement plans, each account will enable you to name beneficiaries and transfer generational wealth. But the Roth IRA is the only account that allows you to leave tax-free generational wealth.
The Roth IRA has two categories for beneficiaries: designated beneficiary or eligible designated beneficiary.
A designated beneficiary is a person who inherits a Roth IRA from a parent (you). The beneficiary (your adult child) will be required to withdraw all the money from the account within ten years following your death. It gives your beneficiary the freedom to withdraw the money on their terms. The beneficiary is not subject to any RMDs, but the caveat is to deplete the account within ten years.
If your beneficiary does not require the money, they can enjoy ten years of tax-free growth as their withdrawals will also be tax-free.
An eligible designated beneficiary applies to minor children, a surviving spouse, and disabled or chronically ill individuals. Beneficiaries falling under this category simply take distributions over their life expectancy, also known as stretching the distributions. But are allowed to take a distribution as soon as they like. The main caveat is if the account they inherit satisfies the five-year test.
In either situation, beneficiaries can inherit tax-free money, which can help them in the long run. As parents, you may want to leave a long-lasting legacy with your children or spouse by transferring generational wealth. If your focus is transferring generational wealth, besides opening a Roth IRA, you will need to create a financial plan with estate planning in focus.
A Roth IRA is robust compared to all the other types of retirement plans and accounts available to you. You already have a 403(b) and/or 457(b), but adding a Roth IRA to your overall retirement plan strategy may be essential. A Roth IRA is vital as it adds flexibility as your financial life changes and becomes more complex and having an additional emergency fund is a great option.
We like to remind our clients that having many options is better than having none and finding yourself in a corner.
You can open a Roth IRA at any brokerage firm and manage it yourself, or an investment professional can manage it.
Get our FREE Roth IRA contribution flow chart
(it's super nice!)
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