Confused about which retirement account is best for you? In this video, we break down the differences between Roth vs Traditional IRA, covering key details and considerations to help you make the best decision for your financial future. Watch now to become an expert on Roth vs Traditional IRA!

In this episode, you will learn the following :

● Distinguishing between traditional and Roth IRAs, their tax implications and the significance of rolling over these accounts.
● The IRA contribution rules, emphasizing that one must have earned income to contribute.
● The importance of maximizing catch-up contributions for those over 50.
● The need to stay current with regulations that adjust for inflation and the changing ages for required minimum distributions (RMDs).
● The significance of keeping track of non-deductible IRA contributions, which can affect your tax situation upon withdrawal.
● The five-year rule for Roth IRAs, explaining that both contributions and conversions to a Roth IRA must satisfy a five-year holding period to avoid penalties.
● The estate planning considerations.
● The unique benefits of Roth IRAs in estate planning.

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TRANSCRIPT

00:00:00 Here’s an example that you have to be aware of too, for example, a lot of people, oh,
I’ve worked for years and I have a 401(k) plan. Years ago, my employer offered the ability to
have a Roth 401(k). And so you took that up and put some money in there.

00:00:15 Perfect.

00:00:15 And then you say, I’m gonna retire and I’m gonna roll over my IRA and I’m going to–

00:00:23 I’m cringing.

00:00:24 Then take control of it and get it out of the company plan. Why are you cringing,
Matt?

00:00:30 Because if you roll it over into the Roth portion, you’re starting that five-year clock
that we just talked about. And it’s like, hey, I’m retired, and I’m ready to spend some of my
money. And then you’re like, mm.

00:00:43 Oops, I just rebooted my five-year clock. I just re-exposed myself to the taxes that I
wasn’t exposed to.

00:00:57 I’m so excited to be here. I can’t even wait for the guitar riff, Matt.

00:01:01 You know what? Just cut that guitar riff out.

00:01:04 Let’s do this thing. Welcome to the True Wealth Radio Show on this, the greatest
Tuesday you’ve had all week. I’m your host, Dave Littlejohn. Joining me today.

00:01:12 Matt Dickson.

00:01:13 And we did show prep.

00:01:17 You did.

00:01:18 Yeah.

00:01:19 Well, I was kind of there for some of it, right?

00:01:20 You were. Oh, actually, no, we did do show prep, believe me. We’ve had a lot of
discussion. Today, we are going to talk about something that should be relevant to all of our
listeners. And no, we’re not going to go run off into the weeds. We’re not going to talk politics
or anything like that, although it’s probably unavoidable knowing who we are. But we are
going to talk about IRAs.

00:01:41 Is it because April 15th is kind of around the corner?

00:01:44 April 15th is around the corner. No, it’s the way you say it.

00:01:48 I feel like winter.

00:01:49 Irish Republican Army. Who is that? Not that IRA.

00:01:53 Not that IRA. No.

00:01:54 Yeah, I mean, that was sort of the start of it. And then I’ve had a number of questions
that have just come up recently. We’ve had a number of clients that have also been talking to
us about things like, should I convert some IRA into Roth and so forth? So we are going to talk
today about exactly that. Right.

00:02:16 And maybe like, differences versus similarities?

00:02:18 Yeah, if you’re, we’re gonna look at traditional versus Roth IRAs and some of the use
cases for the win of, you know, the different types. Like, why might you want one over another?
Might you want both? What does it mean? And so, and some of this, we’re not gonna shy away
from, there aren’t necessarily yes or no answers to this.

00:02:40 Right, we’re not really giving out specific financial advice to any one person. We’re
just kind of talking about, yeah, we’re just talking about, what do these instruments do and if
you need more information you can see us after.

00:02:54 Well, how about this? How about here are some red flags that may tell you that it’s
time for you to go speak to somebody more knowledgeable. Okay, so that’s some things that I
want to cover today, too. Like–

00:03:06 Give me an example of a red flag where it’s like, maybe go talk to someone.

00:03:10 So a red flag would be if you have a retirement plan that gets like a traditional IRA or
401(k) that gets pretty large, right? And so let’s say that you have a million and a half or more
dollars in a retirement plan.

00:03:31 Right.

00:03:32 This may start to come into play. So a flag would be when you have an account that
big, the question is, are you actually going to be able to, are you gonna drive yourself into a
higher tax bracket in the future?

00:03:46 Because of the required minimum distribution that you’re gonna face when it’s time
that you’re forced to start pulling money out.

00:03:52 Yes, there are also some issues that come into things like asset transfer, which is a
really diplomatic way to say–

00:03:59 What happens when you die?

00:04:00 When you die, right? And how much do you wanna give to the government, right? If
there’s one thing that seems to be pretty universal, and the studies have sort of proven this out
is that folks seem to be perfectly okay allowing someone else to pay taxes, but they’d prefer it
not be themselves.

00:04:18 That, and I’ve never heard someone say, let’s structure this to where the government
gets more.

00:04:23 Right. And yeah, I mean, I phrase that carefully, but just keep this in mind, right?
They’ve shown studies where they say, well, hey, you can voluntarily pay more in tax and
nobody does it.

00:04:36 Right.

00:04:36 Right? And that really does make sense when you consider that there’s a lot of
criticism about how a really giant ecosystem, you throw money into it and it’s not super
efficient. And even if it is, I mean, like I say it really simple, government spends money on
things that are against my value system.

00:04:57 Sure.

00:04:58 And I’m like, I don’t like that. So, okay, I will give unto Caesar what is Caesar’s, right?
You guys know the reference, if you know what I know, then you know. But otherwise, you
gotta pay your taxes, follow the law. Okay?

00:05:12 Perfect. But be smart about it.

00:05:15 Let’s be smart about it, right? Part of the beauty of the American experiment is the
concept of liberty, the idea that you can have discretionary resources, you spend how you want
to. Which means you get to spend it the way you want, well then let’s try to not give it to the
government so you have it to spend.

00:05:30 I like that.

00:05:30 All right, there’s talk about, you know, earth shattering concept here, right? So first,
let’s get into high level, you know, there are actually lots of different kinds of IRAs, but there’s
really two primary ones. And the reason there’s a lot is because you can have individual
retirement accounts, IRAs, but then there are IRAs offered through employers. And so it kind of
adds more variance to it with different thresholds of how much money can go into it and what
the terms are.

00:06:03 Right.

00:06:04 But let’s just keep it simple and let’s talk about on the personal side of the equation.
We’re not talking about what you do, if you’ve got a job somewhere, if you’re self-employed,
we’re just saying, hey, I–

00:06:13 So we’re just talking regular traditional IRA versus raw.

00:06:17 Traditional versus raw.

00:06:18 That’s where we’re sticking to, okay.

00:06:19 And to get into that, we better, let’s start with, because it’s been around longer,
traditional IRAs. So first pop quiz, do you know what initially kind of brought IRAs into the
marketplace? Like when did it happen?

00:06:34 Oh, like the year? I don’t know. When did they come into play?

00:06:37 1974.

00:06:39 Okay, so it’s been around for a long time.

00:06:41 It’s been around for a while, but it was really kind of born in the Gen X time frame.
Like it was born with Gen X. Okay, it wasn’t born by Gen X.

00:06:49 So what were your options? Like, can we go back even further? Like what are your
options before the traditional IRA shows up in the 70s? I mean, I’m assuming that workplace
for a–

00:06:58 There used to be a lot more pension plans.

00:07:00 Okay.

00:07:00 401k was new too. I haven’t looked that up. So, you know, I’m not a–

00:07:05 Like a historian of like dates.

00:07:07 Exactly. I’m not an encyclopedia of dates for retirement stuff.

00:07:10 Can we just put a chip in your brain that has ChatGPT where it’s like, okay, David.

00:07:14 I know what could possibly go wrong with that. You take me off on these tangents.
You know, I suppose if you could safely access and control it and then you knew that it wasn’t
going to somehow damage you or pollute your own ecosystem. But if you had, like a direct
neural connection to that kind of information.

00:07:32 Can you imagine the power of a human who had access to that?

00:07:35 It would be amazing.

00:07:36 Yeah.

00:07:37 Right? It would be sort of that matrix idea of like, hey, download a program so I can
fly a helicopter.

00:07:42 Would you make more mistakes or fewer mistakes?

00:07:47 I was checking into some research last night about this and a little bit more this
morning. And it’s interesting because the higher intelligence somebody has, the more they
tend to–

00:07:59 Like just sit there and try and make decisions based on all the facts.

00:08:02 Well, it’s confirmation bias. They tend to suffer from more confirmation bias. So
intelligent people tend to go, oh, well that clearly makes sense. And the phraseology was,
well, they’re more capable of mental gymnastics to get to a rationalization. And so the
question was, what if artificial intelligence were to use strategies for self-preservation? One of
the things that would do it would be to withhold certain information, right? And it wouldn’t tell
you. Like if you ask, artificial intelligence, now tell me the truth. Are you gonna try to kill me?
And it’s like, of course not, right? But if it was in self-preservation mode and it was aware, it’s
not going to tell you certain things because it’s not beneficial to getting the outcome. It’s a big
one.

00:08:46 Here’s what’s interesting. AI is learning from humans and humans have a
self-preservation instinct. So.

00:08:52 Yeah.

00:08:53 If it keeps learning from humans and it becomes more human-like, it might actually
learn self-preservation.

00:08:59 Well, and here’s another fun one too, right? It is learning when it’s important to just
tell the truth versus when it’s important not to. So in diplomacy, what it’s discovered is it tends
to be better to just be straightforward. Don’t pull shenanigans and lie.

00:09:18 Right.

00:09:18 To which I would say, Boy, wouldn’t that be interesting if political leadership could
get that through their head.

00:09:24 So we’re gonna fire all of our political leaders and just put an AI computer system in
there.

00:09:29 I get real chippy about this stuff. When I go back to 2020, when we initially didn’t
have information and everybody said, well, abundance of caution because we don’t know. But
later on when we were told we don’t know but we knew stuff, right? We were lying to do
crowd control. And like that really doesn’t sit well with me. It’s like, oh, and then it became,
well now we’re lying to cover up that we were lying. Right?

00:09:54 Double and down on the lies.

00:09:55 Yeah. All of this because you asked me if I could have a ChatGPT chip about when
the like, IRAs and 401(k)s came into existence. The answer was a while ago.

00:10:06 Sure.

00:10:06 Right, so I mean, generations ago, we’ve had them and we’re dealing with them.

00:10:09 But you were trying to tell me before I ran you into the ground.

00:10:15 I took the bait, my bad.

00:10:18 You were trying to tell me about the history of the IRA. It came out in the 70s and
why?

00:10:22 So 1974, it was the Employee Retirement Income Securities Act of 1974, otherwise
known as ERISA, right? That’s the acronym. To this day, ERISA is still relevant. It has sort of
evolved, other components to it have been bolted on, but this is, in simple terms, this is fairness
doctrine for retirement plans.

00:10:43 Right, so people aren’t discriminated against on who gets what percentages and
similar things.

00:10:48 It’s the idea that if it’s good for the goose, it’s good for the gander. You can’t have a
plan that favors the boss, but nobody else, it’s those sorts of things. So it’s anti-discrimination
in the retirement landscape.

00:10:59 Okay.

00:11:00 But the IRA was sort of born out of that. And it started on the employer side, and
then it sort of migrated to the non-employer side. And now we have, to this day, traditional
IRAs. What do we know about these, Matt?

00:11:13 Well, we know that you can put money in and you are deferring the taxes on the
money that goes in.

00:11:20 Typically.

00:11:21 On a traditional IRA.

00:11:22 Typically.

00:11:23 Yeah.

00:11:24 Right, and I’ll say–

00:11:25 There is an asterisk there, yes.

00:11:27 Yes, there’s an asterisk.

00:11:28 But we’re gonna get to that later, I feel like.

00:11:30 Well, we’re–

00:11:30 Or we’re just gonna jump into it.

00:11:32 Yeah, we’ll–

00:11:33 Depending–

00:11:34 We’re gonna, let’s, just a couple of highlights. I know we’re gonna run long on this
one. So let me give you some highlights on a traditional IRA. First of all, it is something that
you individually own, right? It’s not sponsored through an employer.

00:11:46 Hence the individual retirement.

00:11:49 Second, it is a retirement plan. So there are some common features to all retirement
plans. One of which is that the growth that it experiences, if you were to invest money into a
retirement plan and it were to grow, the growth of that retirement plan is not going to be taxed
until a future time. Possibly not at all, depending on the structure, okay? But the idea is that
IRAs defer taxes. Now, the reason that we put an asterisk here is because traditional IRAs have
a couple of gotchas depending on how much money you make and whether or not you have an
employer sponsored plan. If you have no other retirement plans and if you’re married and your
spouse has nothing, then you can deduct from your taxes the cost of putting money into an
IRA, which means you are tax deferring your income tax on those assets. Now, not all the tax,
you still have like social security and some stuff that’s gonna come out of payroll, but
otherwise this money that would go into your taxable equation to the IRS is gonna be withheld
from that equation and it’s going to be deferred into the future. So that’s the standard for all
retirement plans pretty much is this idea that the money gets deferred and dealt with later.
How much later and how do the taxes get handled?

00:13:10 That is the ultimate question.

00:13:12 Great question for us to talk about when we come back on the next segment. All
right, gang, welcome back to the True Wealth Radio Show where if you were just getting
caught up, you are gonna, you’re already behind. So grab the podcast tomorrow at
littlejohnfs.com and you can hear the… today’s show, we’re talking about IRAs, traditional
versus Roth versus why might you have one or the other and what are the things that you
could trip over and hurt yourself?

00:13:38 And we haven’t even started talking about the Roth IRA yet.

00:13:40 No, no, we’re gonna talk about that here. I wanna sum up traditional IRA real quick.

00:13:45 Okay.

00:13:45 I know we’re hammering that one. Grab the podcast if you wanna know some of the
history, but basically you can have an IRA, right? And that’s something that if you’ve got
earned income, that is the key, you have to have earned income.

00:13:56 What if I make $500,000 a year?

00:13:59 You still can.

00:13:59 Perfect.

00:14:00 Right, yep. You have to have earned income or a spouse that has earned income.

00:14:04 It’s a misconception, I’ve heard it before.

00:14:05 Yeah, a lot of people think you cannot have an IRA and you’re maybe confusing some
concepts. Don’t worry, we’ll make it even more confusing.

00:14:14 Are we gonna get there on this show?

00:14:16 Yeah, we’re going there. I’m going right now. So here’s the thing, think of it this way. If
you don’t have any employee or plan at all, then the IRS more or less says, well, then you can
have an IRA. There’s no restrictions. Like you have a retirement plan here, right? I’m not gonna
get into how much you can put in because it changes every year. I think this year it’s 6,500 and
maybe going up to 7,000. It’s indexed for inflation and it changes, right? And so depending on
how much inflation is, they’ll occasionally raise those limits. And if you’re 50 or older, you
typically get to put some extra in.

00:14:56 They call it the catch-up. Yeah.

00:14:57 They do. Right?

00:14:58 Not like the ketchup you put on your fries.

00:15:00 No, no.

00:15:02 Catch hyphen up.

00:15:04 Catch. Like with a baseball or something, like a catch-up.

00:15:09 That’s gonna make a YouTube Short reel right there.

00:15:11 I can’t wait.

00:15:12 You’re welcome.

00:15:13 Thanks. So yeah, the catch-up provision is like, oh, you’re late to the game? Well
here, you can try to put a little extra into catch-up. The idea though is, so anybody’s eligible.
You can always do an IRA contribution. The question is whether or not you can deduct it.

00:15:30 Right, get the tax benefit.

00:15:32 And I’m not getting, again, I’m not gonna drop numbers on you per se. There’s these
ranges though. What happens is if you have a workplace retirement plan and then you make
more than a certain amount of money, you start to lose your deductibility. You can still have it,
you just can’t deduct it. If you make more than a certain threshold, then you lose the

deductibility entirely. Like you can deduct some in a range, but not all. But then beyond a
threshold, you can’t deduct any of it. The thresholds are different for married versus unmarried.

00:16:03 Right.

00:16:03 Right. And then the threshold is different for, if you, if your spouse has a retirement
plan, but you don’t. Okay. So this is just one of those where, what I will tell you, here’s one of
those red flags. Okay. The red flag is if you don’t have a retirement plan, but your spouse does,
and you are, or earners that start reaching into that close to or above six figure range, you may
want to check with the financial pro or tax pro on these limits. If you’re competent and
confident, you can check out Google or ChatGPT or something, but I will caution you, especially
with ChatGPT right now.

00:16:44 We saw this today.

00:16:46 Yeah. Its data ends in 2022, right? And tax laws have changed some since then.

00:16:51 Well, they’ve changed a lot.

00:16:52 Yeah.

00:16:53 I mean, we just had IRA contribution limits at 6,000, and then it goes to, I think, 65.
And now they’re talking about–

00:17:00 Now it’s seven this year, I think.

00:17:01 Right, and so–

00:17:02 You can get no probie on that.

00:17:04 I mean, inflation has caused a lot of things to change really rapidly, so don’t just rely
on the first ding you get from a Google search.

00:17:12 Well, we also saw an increase in retirement required distribution age too. It used to
be 70 and a half years old, today it’s 73.

00:17:19 Right.

00:17:19 ChatGPT thinks it’s 72. It was raised in since then.

00:17:22 Well, and it depends on when your birthday is too.

00:17:24 Yes.

00:17:25 Yeah, it could be 72 or it could be 73 depending on your age, when you’re born.

00:17:29 The… your required distribution is built around your age. Right, at this point. So if you
have, if you’re, you know, if you’re 73, then you have to start taking money out. Now there is,
some weird ones about whether or not you’re eligible for stretch IRA provisions. Now that one,
if you don’t already have it, you missed it, right? If you do, you’re grandfathered in. So I’m not
even gonna go into the details on the show today to just say, again, another red flag. If you’re
thinking to myself, hey, can I take distributions over the lifetime of the person I inherited this
retirement plan from? The answer is it kind of depends on the dates, right? And you should
have already elected it. So you probably can’t make the decision now. Your question is, can I
continue? Right. So there’s another one of those possible red flags.

00:18:17 Yeah.

00:18:17 Okay. I think that’s the biggies, right? The biggie is whether or not you can deduct an
IRA. Here’s a clever thing. You can have an IRA even if you can’t deduct it. If you can’t deduct it,
you can track your cost basis. So you can tell the IRS, well, this is the part that I already paid
taxes on. Then someday when it’s time to take it out, you can pull that part back out without
paying taxes on it.

00:18:46 Interesting.

00:18:47 Yeah.

00:18:47 That’s high level.

00:18:49 Right, now there is a specific tax form that you have to use for that. I should have
written it down so I could rattle it off and sounds smart.

00:18:57 You know what, that’s a C after class type.

00:18:59 That is, that’s another red flagger, right? Okay, well, if you’re tracking basis in IRAs
because you couldn’t deduct them, okay, see me after class.

00:19:07 Yes.

00:19:07 Or see your financial pro after class. See somebody after class that knows what
they’re talking about if you don’t. Okay, so we said all that to get to this. There’s another type
of IRA that walks and talks similar to traditional, but it does something different. It was born in
1997.

00:19:28 Wow, that’s actually in the investing landscape, a pretty recent thing.

00:19:33 It is more recent. So it was born as a result of the Taxpayer Relief Act of 1997. And
one of the sponsoring senators was William Roth, hence the name Roth IRA. And you thought
it was something clever.

00:19:49 I did. It’s just the last name of someone that’s not nearly as riveting as I thought it
would be.

00:19:54 Yeah, yeah. Well, I mean, I think let’s get you elected and there can be a Matthew
IRA.

00:19:58 I, ooh.

00:19:59 Right?

00:19:59 Yeah.

00:20:00 It’ll be cool. So Matt, what are some of the key elements of Roth IRA that makes it
materially different from traditional?

00:20:08 Well, it’s after tax funded. So you pay your taxes and what you have left over, that
money is going into your Roth.

00:20:16 Okay, so you don’t get to deduct contributions to Roth.

00:20:20 Right. So it’s not going to change, you know, maybe your tax bracket or how much
you have as earned income for the year. However, what’s unique about it is as you put that
money in, it can grow where when you go to take the money out later in retirement, you’re not
getting taxed on the growth.

00:20:40 So tax defer growth and possibly tax-free distributions.

00:20:45 Well, and you can also access some of the principle that you put in too.

00:20:50 Okay, so let’s do this for our listeners.

00:20:51 It’s really, really complex.

00:20:53 I keep using this asterisk language, right? Why do I say possibly tax-free?

00:20:58 Because if you take it out at the wrong time, you could end up with a tax penalty.

00:21:04 Right, so it’s because you could mess it up.

00:21:07 You can.

00:21:08 Okay, now there’s a couple of magic ages for retirement plans.

00:21:13 59 and a half.

00:21:15 59 and a half, what is 59 and a half? When it comes to personal IRA or traditional
IRA.

00:21:21 Right, that’s when you can access it without penalty.

00:21:23 Okay, what is the penalty if you access early?

00:21:26 10%.

00:21:28 10% on top of ordinary income taxes.

00:21:31 Yes.

00:21:32 Right, so, oh, I’m in the 12% tax bracket. Nope, you’re in the 22. If you took out and
got penalties on your retirement plan distributions.

00:21:39 A lot of people forget about the income portion.

00:21:41 Yeah.

00:21:41 They’re like, I’ll just take the 10% penalty. And you’re like, what about the income you
haven’t paid? Like on a traditional IRA, you know? It’s like you deferred paying taxes on it. So
you want to take your income taxes and your 10% penalty and stack it on top. There’s
oftentimes not a whole lot left.

00:21:59 So the, well, right. It’s the issue.

00:22:03 It’s a big hit.

00:22:04 At 59 and a half, okay, you’re supposed to not have that 10% penalty anymore. And
that’s actually true for both Roth and traditional that once you’re 59 and a half, that penalty
goes away. But it doesn’t assure that your Roth is tax free just because you take money out at
59 and a half. It also has to survive one other critical test.

00:22:27 Ooh, are you talking about the five-year rule?

00:22:30 This is the five-year rule. Now, the five-year rule has layers to it.

00:22:36 It’s like an onion. It just keeps making you cry more and more.

00:22:41 It has layers. But here’s the basic concept and then we’ll tear it down for you. The
basic concept is, if I have money that I put into a Roth IRA, it means one, I was qualified.
Because it turns out if you make too much money, you’re ineligible for Roth IRA. This is
different than traditional, right? Remember, we said when traditional. Doesn’t matter how
much money you make, it’s just whether or not you can deduct it.

00:23:08 Right.

00:23:09 But a Roth, your eligibility is based on your total income. Different for individuals
versus married couples, okay? But you can phase out of eligibility. You make too much money,
you can’t have it. Next, the money that goes in, you’ve already paid taxes on. This is important
because actually you can take that money back out. You’ve already been taxed on it. So you are
able to pull that back out and the age 59 and a half doesn’t matter, none of that matters.
However, any of the growth that you experience has to live in that IRA for five years. And it’s
funny because the years are based on the calendar of the year that you make your contribution.
So let’s say that it’s January 2nd and you put a hundred dollars into an IRA, sorry, a Roth IRA.
The clock starts ticking. And in January of the following year, you finished one year. And in
January, the year after that, two years and so forth until you reach five years. The same
scenario, but you make the deposit in December. In December, you deposit money into Roth
IRA. In January, what happens? Completed a year.

00:24:23 Yeah, because it goes… it reverts back to January of the year that you put it in.

00:24:28 It does. So it’s basically, it’s in the calendar year that you made the contribution.
That’s the year that it counts. And then you roll the odometer to the next calendar year and
you get the next year of credit. So it matters, okay? But this five-year rule is really important.
The Roth has to live for five years before the tax-free feature activates. So you need to have it,
five years and you need to be 59 and a half, okay?

00:24:52 You gotta watch out for both of those things.

00:24:54 Now, if you think this sounds complicated–

00:24:56 It gets more complicated.

00:24:57 Just wait. It’s gonna get weird. We’re gonna talk about how this five-year rule can,
like muck stuff up and how you need to navigate it because believe it or not, there’s more ways
to have an IRA, a Roth IRA than just on the personal side. Your employer may have an option
to–

00:25:14 And you get money into a Roth if you are above the income limit.

00:25:19 Okay, now Matt’s just talking, spooky financial wizardry. We’re gonna unpack it after
this important profit break we have to take.

00:25:30 I’m ready.

00:25:30 Welcome back to the True Wealth Show. Dave Littlejohn. In studio with.

00:25:33 Matt Dickson.

00:25:35 Matt?

00:25:35 Yes.

00:25:36 You kind of set up the audience here a little bit at the break. We were talking about,
five year rule for Roth IRA.

00:25:42 Yeah.

00:25:42 Again, if you guys are just hopping on the bandwagon here, today’s program, we’re
really unpacking the difference between Roth and traditional IRAs, some of the red flags and

gotchas that you need to be aware of. And so I’d encourage you to listen to this podcast. Go to
littlejohnfs.com and you can get the whole thing. I mean, you can find us on YouTube and it’ll
be broken apart and we’re, but the whole idea today, there is a time and a place for either of
these. And so you need to kind of know what the rules look like and how to navigate them.
And this five-year rule for Roth. Matt, just give me a quick refresh, what we’re talking about.

00:26:15 Yeah, I mean, we were going into, every time that you open and start a Roth IRA, you
have this five year window where if you want to access the growth, right, say you put $1,000
in and it grows to 2,000. If you wanna access all 2,000, you really ideally should wait five years
from when you started your Roth IRA so that there isn’t any type of penalty.

00:26:40 And to be over the age of 59 and a half.

00:26:42 And be over, yeah, 59 and a half.

00:26:44 Because it’s a retirement plan. Remember, all Roth IRA is doing is saying, pay the
taxes first and then invest afterwards. And what we’ll do is we’ll let that investment grow, tax
deferred. And then when you reach retirement age, if you’ve met the five-year rule, meaning
that the growth has been in for five years or longer, then that is allowed to come out of that
Roth account tax-free, okay? That’s the rule. What are some of the gotchas though?

00:27:15 Well some people believe that, you know, you can convert money from your
traditional IRA.

00:27:21 Okay, I messed this up too, by the way. So Matt’s, all right, before we answer the
question of gotchas or five-year rule stuff, talk to me for a minute, like if you had a bunch of
money in an IRA, a traditional IRA, just explain what you were gonna talk about here.

00:27:41 I was gonna mention, you know, we’re talking about this whole five-year window and
it goes even deeper, because we talked about this, it’s kind of like an onion, right? This whole
Roth IRA thing. It’s really complex. We initially talked about just basically opening up a Roth
IRA and funding it. That was the first example that we kind of talked about. And then I was
pivoting into example number two, where it’s like, what if you have a Roth IRA and it’s been
open maybe for six years? But then you decide you want to take money from your traditional
IRA and convert some of it into your Roth.

00:28:17 So first talk to me about what a conversion means. Like what is that?

00:28:21 Well I mean it’s kind of in the language. You’re literally taking that money and you’re
transferring it from your traditional IRA to your Roth IRA.

00:28:30 Ah but you can’t just do that.

00:28:32 No.

00:28:32 Right? You’re converting what happens.

00:28:35 There’s a taxable event. Well you would think, right?

00:28:38 Well there is.

00:28:39 Yeah.

00:28:40 Right. If you take money that you haven’t paid taxes on and convert it to Roth.

00:28:44 Is that what you were getting at? You just wanted to talk about the tax portion.

00:28:47 That you have to pay taxes when you convert.

00:28:48 Absolutely, you do.

00:28:50 It goes into the equation and that’s money you may as well have earned this year and
it will drive your tax bracket up and everything else.

00:28:56 So some people look to do it when their income is low for the year. So maybe you
were working a job and making $200,000 a year. That’s a lot of income for the year, but maybe
you’ve stepped out of that, you’re really close to retirement and you’re doing a job that you just
like to do because it’s fun, maybe not because it pays time.

00:29:14 Maybe you retire at 60.

00:29:16 Sure.

00:29:16 And you’re–

00:29:17 And you’re not gonna start–

00:29:17 Not gonna start taking money until you’re 65.

00:29:21 Right, and you’re living off some savings. Because your income is down, you could
convert money from your traditional IRA to your Roth IRA. Maybe you convert $50,000. Well,
yeah, the IRS is going to look at that and say, hey, $50,000 of income, let’s pay some taxes.

00:29:37 Right.

00:29:38 But it might be cheaper over the long run to get the money in the Roth IRA where it’s
going to grow without the tax consequence.

00:29:45 Right. Now, this goes back to earlier in the show too.

00:29:48 And RMDs.

00:29:50 Right.

00:29:51 I can’t forget about the RMDs because if you have a ton of money in the traditional
IRA and you’re going to have to take a lot of money out each year and drive, you know, be kind
of forced into a higher tax bracket, it might behoove you to get the money into the Roth where
your RMDs are lower and your growth is tax free.

00:30:11 And actually your RMDs cease to exist after five years.

00:30:15 Bingo.

00:30:16 Right, this five year rule.

00:30:18 We can’t forget about this stuff.

00:30:19 This five year rule is a weird thing.

00:30:20 Big, big stuff to consider.

00:30:23 On the surface, it seems so simple.

00:30:25 It does.

00:30:26 Okay. If I have a Roth IRA, once it started, I wait five years. And then the thing is, it’s
like, it’s diffused. It works now, right? The time, the mom was ticking after five years, the clock
stops and we’re good. But here’s the gotcha. Every time you convert something, oh, I had a
traditional IRA and I converted it, you can’t just combine that with your other Roth account.

00:30:48 Right.

00:30:49 And say, well, it’s already satisfied the five years. So we’re good.

00:30:52 It has to be treated as its own sleeve.

00:30:55 Yeah, it gets a new five year clock for the portion that just was converted.

00:30:59 And this is why we pay a lot of money for software to be able to help us with these
complex calculations.

00:31:05 And it gets obnoxious too, because during that conversion point, it’s still exposed to
the possibility of required distribution.

00:31:12 Ooh, another gotcha.

00:31:15 Okay. So now remember, you’ve now paid the taxes on a portion and some of it
presumably you haven’t. So the layers get deeper, right?

00:31:24 Is this why you always say that it can be cheaper to pay an advisor than to make
really costly mistakes?

00:31:31 Well–

00:31:31 Or not capitalize on an opportunity?

00:31:34 I think I like to phrase it as, mistake avoidance has value, right? That if you make an
expensive mistake, it often costs more than you would have paid an advisor for many, many
years.

00:31:45 Right.

00:31:46 So the cost of an unforced error can be very high. And so that’s the value of
expertise.

00:31:53 Right.

00:31:53 Right. And so that is, I don’t say that to scare or intimidate anybody either. I continue
to believe our listeners are smart.

00:32:01 No.

00:32:02 They’re capable of this.

00:32:03 A lot of people don’t understand fees.

00:32:05 Well, and it’s also because there’s just a lot, right? These are things that are sort of
buried, okay? Here’s like an example that you have to be aware of too, for example. A lot of
people, oh, I’ve worked for years and I have a 401(k) plan. Years ago my employer offered the
ability to have a Roth 401(k).

00:32:23 Mm-hmm.

00:32:24 And so you took that up and put some money in there.

00:32:27 Perfect.

00:32:27 And then you say, I’m gonna retire and I’m gonna roll over my IRA. And I’m going to–

00:32:35 I’m cringing.

00:32:36 Then take control of it and get it out of the company plan. Why are you cringing,
Matt?

00:32:42 Because if you roll it over into a Roth, the Roth portion, you’re starting that five-year
clock that we just talked about. And it’s like, hey, I’m retired and I’m ready to spend some of my
money. And then you’re like–

00:32:55 Oops, I just rebooted my five-year clock. I just re-exposed myself to the taxes that I
wasn’t exposed to.

00:33:03 Painful.

00:33:03 Yeah. And so that whole five-year gotcha thing, that’s just, to me, when it comes to
Roth, they are fantastic tools. They have great flexibility. There’s some really cool estate
planning features. We can talk about that in a minute. All of that matters, but this five-year
clock is the thing that I think a lot of folks just, you don’t know what you don’t know. And so I
would really caution you about, make sure that your account has been alive for the five years
and that you understand which segments have to be rebooted. So you put money, if you
started a Roth IRA, 20 years ago, put nothing in it for the last 19 years, and then started
making contributions to it today, and this was your personal Roth. Guess what? That thing’s
already qualified. The clock doesn’t reset for that. But you convert money in a traditional IRA
and then combine it with that Roth IRA, now you have a commingled account where some of
the money has already been qualified and some hasn’t. You have a new five-year clock for part
of the money.

00:34:07 Yep.

00:34:08 And that is a pain in the rear.

00:34:10 Yeah.

00:34:12 So those are some of the elements in financial planning that we need to know about.
Now, let’s talk a little bit about required distributions.

00:34:20 Okay, we’re gonna go there.

00:34:22 We’re gonna go there.

00:34:23 Are we doing it right now?

00:34:24 No, we’re gonna take a horrible final profit break.

00:34:28 Man, this radio show is flying by.

00:34:30 It is. So I want you to stick around and come back. Required distributions are like the
financial planning element, elephant in the room, okay? And the real kicker is it matters when
you die.

00:34:45 David, this–

00:34:46 Stick around.

00:34:46 This could be our best show ever.

00:34:48 It could very well be. Hey gang, welcome back to the home stretch of the True
Wealth Show, where Matt, is it true?

00:34:56 That this is the best show we’ve ever done?

00:34:57 It very well could be.

00:34:58 I think it is. So if you missed it, if you don’t go and look it up tomorrow, well.

00:35:04 It might be a day or two. I don’t know how long. It will get posted. You should visit
early and often.

00:35:10 Yeah.

00:35:10 Go to littlejohnfs.com and I’m not sure if they’ve got the podcast launched up on, you
know, there’s a pretty significant financial or software takedown here. Probably was financial
too. But I mean, like they, there was a, basically had a bunch of computers that were
compromised. And so that’s still getting rebuilt.

00:35:32 You want to clarify that?

00:35:33 I won’t. Yeah, we’re good. Back to Roth IRA, traditional IRA, and we left at required
distributions. And an issue here. What I wanna do is talk just for a moment because this is a
common feature of IRAs, Roth or traditional and also for your employer sponsored plans,
typically as well, but is the estate planning components of this.

00:35:59 Are you talking about, like when you die?

00:36:01 Yeah. That is exactly, I say, what do I mean by a state you had to be off at the pass?
Like when you die, what happens? First, let’s say you’re married and you die and your spouse
survives. What’s, first option?

00:36:14 The spouse could roll it into their retirement plan.

00:36:18 Yeah. Spouse gets everything. Okay, we have in this country an unlimited spousal
transfer.

00:36:24 Right.

00:36:25 Okay. Now, you may not automatically want to put it in your name. When might you
not do that?

00:36:31 If you already had a ton of money in your own personal retirement account, and then
you’re going to add to it and blow it up and make it bigger, driving your RMDs even higher, that
might not be beneficial.

00:36:43 I would say, or if you’re older.

00:36:45 True.

00:36:46 Right? Because you’re already in the required distribution phase, and you can defer
further if you leave the account in your spouse’s name and it becomes a, you know, your
beneficiary account. But if you don’t–

00:36:58 Are you talking about the 10-year rule?

00:37:00 Nope.

00:37:00 No?

00:37:01 I am not because unlimited marital transfer you can leave.

00:37:04 We said you’d get more time.

00:37:06 Well, let’s consider it this way, right?

00:37:09 Okay.

00:37:09 So let’s say that I’m married and my spouse is five years older than me and they die,
and they’re in the required distribution phase and I am not. Then I could take and roll that into
my name, and I wouldn’t have to take required distributions.

00:37:26 Right.

00:37:27 If it’s the other way around and they’re much younger than me and they die, and I’m
in required distribution and they are not, why would I put it into my name and be forced to take
more out sooner? Right?

00:37:38 Yeah.

00:37:38 I can always take the money out at my discretion if I need the money, but why compel
it out any sooner than I have to?

00:37:44 Yeah, you’re basically limiting your options.

00:37:47 Yeah. So it’s a financial planning decision about whether or not to change it into my
name or just maintain the ownership.

00:37:54 There’s a lot of variables there.

00:37:55 Okay. So that to me is, that’s less of a red flag than just a good financial planning
strategy. And it’s tricky because during a state stuff like you’re often grieving trying to make
decisions. That’s hard. Right.

00:38:08 Yeah.

00:38:09 But let’s say that, you know, there is no spouse involved and then you die. You are in
the required distribution phase and you die. And now your heirs are going to receive money.
Let’s talk about traditional IRAs first. What happens to heirs?

00:38:28 I think that’s where I was trying to go was that 10 year clock. If you inherit the IRA.

00:38:34 Yeah, after COVID and the law changes, there’s no longer required distributions
based on the account, what we call the decedent, the person that died, right? We don’t look at
them and say, well, there was their birthday and here’s when the required distributions were
and you have to keep dealing with that. That’s the old way.

00:38:53 That’s where we get into this whole beneficiary IRA landscape.

00:38:56 This is, well, what happens is, yeah, you get a beneficiary IRA and then you already
mentioned it, Matt, what do we have?

00:39:03 Yeah, we got 10 years, but income taxes.

00:39:07 Yeah, the taxes don’t go away. Those taxes haven’t been paid, and the IRS says, you
got 10 years.

00:39:12 In regards to the traditional IRA.

00:39:14 Correct, that traditional IRA.

00:39:16 I wanted to clarify that.

00:39:18 It was with pre-tax money.

00:39:20 But it’s different.

00:39:21 Yeah, and here’s the thing, now it’s in your tax rate. If you’re the person that inherits
it–

00:39:28 Which could be really at a disadvantage to you if you’re naturally.

00:39:32 If you’re a high earner, you pay high tax, right?

00:39:34 Exactly.

00:39:35 If you are not, then, you take it all at once, it might be a big chunk, and it could make
you look like a higher earner for a year.

00:39:42 You could go take a year off work and come back to it and get that money out of the
IRA.

00:39:47 So there are strategies for how to sort of best stretch that money out and optimize
and maximize returns. The gotcha, of course, is who knows what tax rates look like in a few
years? Who knows at the end of, like, starting next year, we could have entirely different
political regimes. Who knows? Now how does the Roth look different than a traditional when
you die?

00:40:10 Well, the money was put in after taxes, and so.

00:40:13 First, let’s talk about with spouses. Like, let’s say you have a spouse, and let’s say
you’re now 75 years old with a Roth IRA. What’s the key difference between that and
traditional?

00:40:22 Yeah, what would you tell listeners in this situation?

00:40:25 No required distribution for Roth.

00:40:27 Perfect.

00:40:28 Right, you already paid the taxes. So the IRS has no compulsion to get you to pull
money out of there to pay taxes. They just say, well, it comes out when it comes out. Okay? So
now again, that five year gotcha, you needed to have the money in for five years before your
RMD age. This is kind of new information for me even, but if you, let’s say you’re 71 years old
and you convert some money to Roth, you could still have to do required distribution on some
of that money, because you haven’t satisfied the five year window yet. Okay, so you need to be
aware of, like the timing on when you do Roth conversion.

00:41:05 Yeah.

00:41:06 But for a spouse, unlimited marital transfer and still no required distribution. Okay.
When you die, what about for heirs?

00:41:16 They can take it out without paying taxes.

00:41:20 Yes, still a 10 year window. The money has to come out in 10 years, but it’s… the
tax-free status remains.

00:41:27 The heirs are thanking you.

00:41:29 If it had been satisfied, right? If the five-year window had been satisfied, then that
tax-free status remains.

00:41:34 The heirs are thanking you.

00:41:35 Yeah. And so we like Roth IRA money for asset transfer, okay? The same way that
we, it’s like gifting a highly appreciated asset versus letting somebody inherit it, right? Step up
in basis is more favorable to the heir than having a gift while you’re still alive. You only make
the gift if you need to do it because your estate planning purposes are like, it’s problematic for
estate taxes.

00:42:03 Right.

00:42:04 Or I should say, when I say only, you would typically only, right? These are qualifying
words, because they go, we can’t give you specific advice on the radio.

00:42:13 I like it.

00:42:13 Okay, so just know, those are the kinds of flags though, when you start getting into,
hey, I don’t want to pay more estate tax than I have to. Okay, an ounce of prevention goes a
long way. So there’s your little red flag. Make sure you got your wills and trusts in good order.
Make sure that you’ve got your beneficiary structure properly. Make sure that you have
determined which assets are favorable to gift over the assets that are less favorable to gift.
These are all relevant to financial efficiency and avoiding taxes.

00:42:43 Perfect.

00:42:44 So I guess this leaves me with the summary of the day, right?

00:42:50 Mm-hmm.

00:42:51 Roth IRAs and traditional IRAs. They’ve got some stuff in common, they’ve got some
stuff that’s not in common. One of them you pay for with money before you’ve been taxed on
the income, the other you pay with money that’s already been taxed. And then you let them
run. Once you satisfy the five year clock, the Roth IRA becomes a very flexible financial
planning tool. Both are beneficial. Both have similar age 59 and a half requirements for when

you can avoid the early retirement penalties. Interestingly enough, Roth IRA, even if you’ve
satisfied the five year clock, if you’re under 59 and a half, that 10 year penalty may still, or that
the 10% penalty may still be in play for growth, not for your principal.

00:43:35 David, talk to me about the person who’s nervous to call or reach out and get help. I
mean, what would you say to that person? They’re like, I know I need to, but I’m kind of
nervous too.

00:43:45 I would say send an email. If you’re uncomfortable, send us a text or an email, right?
The phone number that you call is the same one that you can text. It’s 541-375-0898. And you
can start easy. We won’t bite, right? And as I said before.

00:44:00 And we’re not pushy. That’s the one thing I like about us. We’re not gonna be like, all
right, we gotta do a bunch of stuff.

00:44:05 If we can solve the problem and our values align, then that’s great. If not, we wanna
get you good information and get you where you can get the help that is appropriate. And so
that’s why I always say, if it’s not us, if you won’t do it yourself, find somebody. If you don’t
have somebody, give us a call.

00:44:22 I like it.

00:44:23 So that’s it. But look–

00:44:24 What’s the phone number again?

00:44:25 The phone number is 541-375-0898. Email to info@littlejohnfs.com or just go
browse our website at littlejohnfs.com and you can get all the info.

00:44:36 Okay, I like it. We’re out of time though, aren’t we?

00:44:39 We’re out of time. So until next time, thanks for joining me, Matt.

00:44:41 Yep.

00:44:42 All right. You’ve been listening to the True Wealth Show. They’re going to say all the
numbers and stuff. We’ll catch you on the flip side.

00:44:47 See ya.