Suze Orman teaches about converting a 401k retirement account to a Roth IRA . Check out more personal finance videos and walk throughs about Term Life Insurance, Whole Life Insurance, Debt, 401k Investing, and Financial Planning with Suze Orman, Dave Ramsey, and Greg Olney here at
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Suze Orman is a well-known financial expert who is acclaimed for her work on financial literacy and advising people on their financial health. In 2010, Suze Orman spoke extensively about the Roth IRA rollover for 401k’s.
A Roth IRA is a type of individual retirement account that allows an investor to save money on a tax-free basis. It allows contributors to withdraw their contributions tax-free, even before retirement age. The Roth IRA is popular among those who expect to be in a higher tax bracket in retirement. The Roth IRA Rollover is a process of transferring funds from a traditional IRA or employer-sponsored 401k plan to a Roth IRA.
Suze Orman was vocal about the Roth IRA Rollover in 2010, as this was the year where taxpayers could take advantage of a special tax rule. Under this rule, taxpayers can convert their traditional IRAs or employer-sponsored 401k plans to Roth IRAs, irrespective of their income level. Previously, high-income earners were not eligible to make Roth IRA conversions.
Suze Orman stressed the importance of understanding the pros and cons of a Roth IRA rollover to make informed decisions. Factors such as the investor’s age, tax bracket, and investment goals are essential in deciding whether a Roth IRA conversion is suitable.
One of the most significant advantages of a Roth IRA conversion is the potential for tax-free growth. Seize the opportunity to invest in a Roth IRA is good – provided investors have the funding available to pay taxes on the conversion. The conversion could result in a higher tax bill in the short-term, but the investor can save more money in the long term.
Suze Orman also advised investors to consider factors such as estate planning and legacy goals, as Roth IRAs offer flexibility and tax advantages for leaving money to heirs. Roth IRAs do not require minimum distributions, and investors can continue to contribute even after age 70 1/2. However, heirs inheriting Roth IRAs have to follow specific rules to avoid penalties.
In conclusion, the Roth IRA rollover is an essential option for investors looking for a tax-efficient way to save for retirement. With the tax rule change in 2010, high-income earners could take advantage of the Roth IRA conversion, regardless of income levels. But Suze Orman reminded investors that the decision to convert must be based on their unique financial and investment goals.
—I've heard Ms. Orman many times recommend that employees not put more in a traditional 401K plan than what they need to maximize their employer's matching, unless they have additional income to save after maximizing their Roth IRA contributions. However, I believe Ms. Orman has overlooked several benefits of 401K plans, and also the disruptions to steady employment and job changes that many people experience over a career that can devastate one's ability plan to fund retirement savings consistently over a career and thus have enough saved at retirement:
—1) 401K plans allow employees to put away 3 to 4 times more money annually than IRAs. In 2017, people under 50 years of age can contribute up $18,000 in a 401K versus $5,500 in an IRA; a person 50 or older can contribute an additional $6,000 in a 401K versus $500 additional in an IRA. Thus, annual contributions for a person 50 or older, can reach $24,000 for a 401K versus a lousy $6,000 for an IRA. I say that $6,000 is lousy because tables that project $6,000 annual contributions could reach over $1 million in retirement assets over a 30 year career assume a person will have uninterrupted employment and annual contributions consistently over 30 years. However, as we know the days of one steady job over a career are over. Millions of people including many highly skilled and educated have disruptions during their work careers: these disruptions can include the loss of a high paying job, extended periods of unemployment, reemployment in a temporary lower paying job with no 401K plan, reemployment as a independent contractor with no 401K option, illness or other emergencies that drain retirement savings. Because of these disruptions and a low savings rate, many people are likely to have deficient savings as they approach retirement. Thus it would seem important to encourage people to save as much as possible in pretax and tax deferred 401K plans during their working years and to start saving when they are young to maximize the years of compounded returns. This means people should seek to put away the maximum $18,000 annually in 401K plan when they can as 30+ years of uninterrupted employment and access to a employer sponsored 401K plan is by no means a certainty.
—2) 401K plans allow employees to save pretax income. I can't recall if Ms. Orman mentioned this. Pre tax means, an employee in the 25% tax bracket can save $1,000 in their 401K plan for every $750 that they elect not to receive as after tax take home pay. That's an immediate 33.3% return, plus all of the income generated by the $1,000 is tax deferred out to retirement. Thus, a 7.2% annual return over a 21 year period would grow $1,000 to $8,000. By comparison, $750 of after tax take home pay in an Roth IRA would grow to only $6,000. I believe this benefit makes the 401K a worthy place to put savings above the employer matching.
—3) Thus, any comparison between Roth and traditional (IRA or 401K) IRA that assumes both are funded by the same amount of money is an unfair comparison. In such a comparison the Roth would always look better–it would be a no brainer. However, in reality, any person who has $100K of after tax money to put in a Roth should have more than $100K of pretax money to put in a traditional; the difference would be the taxes. Thus, the comparison should be $100K of funding for a Roth versus $100K plus the pre tax savings added back for a traditional. At a 25% tax rate the tax savings would be $25K which, when added back to the $100K, would be $125K. Thus, if $100K in a Roth grows to $800K, $125K in a traditional would grow to $1 million which would be $200K more. That is a more fair comparison and is not a no brainer.
4)Then, if the person's tax bracket in retirement remains at 25%, the retiree's taxes on $1 million could be $250K which would be $50K more than the $200K of additional investment growth in the traditional over the Roth. However, such a $250K tax liability assumes the retiree would withdraw the entire $1 million during their retirement years. However, we know that many middle class retirees have other resources–other savings, social security, pension income, part time income and spousal resources–that they live on along with ahead of drawing from their 401K. Also, unfortunately many people die early into their retirement years or even before their retirement. Such retirees might leave a considerable portion of their retirement savings to their surviving spouse and children. However, if they had paid $25K in taxes up front in order to fund a Roth account they would deprive their surviving spouse & children the opportunity to benefit from $200K of additional savings. Similarly, a surviving spouse might not draw down and thus be taxed all of their deceased spouse's retirement savings but would leave some of it to their children…
5)…and even if a surviving spouse and children must meet annual withdrawals that would be fully taxable in an inherited traditional or 401K or IRA, the minimum withdrawals could stretch out full liquidation of the account, over many years. Over all of that time they would still have some portion of the $200K of additional money in the traditional that would be invested and growing. Thus a child with a life expectancy 30 years after the last surviving parent could stretch out withdrawals and thus defer some amount of taxes in an inherited traditional 401K or IRA over an additional 30 years.
Thanks for posting this info.