Before you do a Backdoor Roth IRA in 2024, you need to be aware of the Pro Rata rule if you have a pre-tax balance in your Traditional IRA. Let me nerd it down for you.

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⏰ Table of Contents ⏰
0:00 The Roth IRA Terms
2:06 Backdoor Roth IRA Process
3:49 YNAB
4:26 Pro Rata Rule Explained

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Disclaimer: This video is not in any form of personalized financial advice. I am solely sharing my personal experience and opinions. All Strategies, tips, suggestions, and recommendations shared are solely for entertainment and educational purposes only. There are financial risks associated with investing. You must conduct your own research and due diligence or seek the advice of a licensed advisor if necessary.

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BEWARE of This Weird Roth IRA Rule (It’s Stupid)

When it comes to saving for retirement, a Roth IRA can be a great tool. It allows you to contribute after-tax income, and then withdraw the money tax-free in retirement. However, there is a bizarre rule that many people may not be aware of, and it can have a significant impact on their retirement savings.

The rule in question relates to the “five-year rule” for Roth IRA withdrawals. According to this rule, in order to withdraw earnings from a Roth IRA tax-free, you must have had the account open for at least five years and be at least age 59½. If you don’t meet these requirements, the earnings portion of your withdrawal may be subject to taxes and penalties.

This rule can be particularly problematic for those who have multiple Roth IRA accounts. For example, if you have a Roth IRA that you opened 10 years ago and another that you opened just three years ago, the five-year rule will apply separately to each account. This means that even if you meet the five-year requirement for one account, you may still have to pay taxes and penalties on any earnings you withdraw from the other account.

This rule is especially frustrating because it penalizes savers for being proactive and opening multiple retirement accounts. Many financial advisors recommend diversifying retirement savings by opening multiple accounts, but the five-year rule can make it more complicated and costly to access those savings in retirement.

The rule becomes even more convoluted when you consider rollover contributions. If you roll over funds from one Roth IRA to another, the clock on the five-year rule starts over for the new account. This means that even if you had a Roth IRA open for more than five years, if you rolled funds into a new account, you may have to wait an additional five years before you can withdraw earnings tax-free.

It’s not just individuals who are affected by this rule; even financial institutions can struggle to keep track of the five-year requirement for their clients. This can lead to confusion and potential tax issues for account holders who may not be fully aware of the rule and its implications.

In order to avoid falling foul of this rule, it’s important for individuals to keep careful records of when their Roth IRA accounts were opened, and to be aware of the implications of rolling over funds between accounts. It’s also advisable to seek advice from a financial advisor who can help navigate the complexities of retirement savings and ensure that you are maximizing the benefits of your Roth IRA.

In conclusion, the five-year rule for Roth IRA withdrawals is a strange and nonsensical provision that can have a significant impact on retirement savings. It punishes savers for being proactive and can create unnecessary complications when it comes to accessing retirement funds tax-free. It’s important for individuals to be aware of this rule and to take proactive steps to minimize its impact on their retirement savings.