Roth IRAs Part 2: Tips and Techniques

In my last post, we covered the basics of the Roth IRA and discussed how this type of account can help you and your family build and transfer tax-free wealth.  In this post, we explore some additional tips and techniques to get the most out of your Roth IRA.

Consider Elements of Timing
They say in comedy, timing is everything.  Well, a Roth IRA is no sitcom but if you pay attention to a few matters of timing you are sure to get a smile when you look at your statement.  First, remember there’s a 5-year clock.  The Roth IRA must be in existence 5 years before the underlying growth avoids further taxation.  So, to get the downstream benefits it is important to get the clock started, and the sooner the better. 

One aspect of timing some overlook is this – when you rollover your Roth 401(k) plan balance to a new Roth IRA (for example, when you leave an employer), the 5-year clock starts from the time the new Roth IRA was opened.  You receive no credit for the time the funds were held in the Roth 401(k).  As such we generally advise those who contribute regularly to an employer’s Roth 401(k) plan to also establish a Roth IRA as soon as possible.  This will help you avoid what might otherwise lead a timing surprise later.

While we do not advocate market timing, a periodic dip in market indices may create a window of opportunity for making a Roth IRA contribution or a Roth IRA conversion.  Market indices fluctuate regularly and in any given year we may experience a 5-10% retreat from a recent high point.  When such a pullback occurs, consider it an opportunity to move funds into your Roth IRA.  You may miss the absolute bottom of a bout of volatility (you can never really know ahead of time what’s to follow) but moving those funds into the Roth IRA at a relative bottom is better than making no move at all.  By strategically timing a Roth IRA conversion you will enjoy watching the assets converted appreciate in a tax-free manner and chuckle at how you cleverly reduced your future Required Minimum Distributions.

Consider the Allocation
As planners and fiduciaries, we help clients establish their financial goals and then align the risk to their investable assets in such a way to increase the likelihood of achieving those goals.  Because of its unique tax characteristics, the Roth IRA can be flexible and molded to fit a variety of goals.  For example, a long-term investor with adequate resources to meet spending goals may have no specific plans for his Roth IRA other than to leave it to his heirs.  In such a case, the risk profile for the funds in the Roth IRA may be aligned to the goals of the investor’s heirs, and if those intended heirs have no immediate need for the funds then it may be prudent to invest the Roth IRA more aggressively to maximize long-term growth.  On the other hand, a tax-bracket conscious retiree who periodically withdraws funds from his Roth IRA may wish to take less risk and even hold a portion of the assets in safer, less volatile money market funds to meet spending needs.

Keep in mind that even if it is prudent to take more (or less) risk with Roth IRA assets, such risk need not skew the asset allocation across the entire portfolio of accounts.  You can allocate a higher percentage to stocks, for example, in a Roth IRA, and a lower percentage to stocks in a Traditional IRA or other tax- qualified account and still achieve the right balance of risk across all accounts.  As noted above, one technique to reduce Required Minimum Distributions over time – and the taxes that follow – is to take less risk with tax-qualified accounts and offset that lower risk with a more aggressive stance in your Roth IRA.

Consider the Purpose
Investors oftentimes compartmentalize their financial assets and designate certain funds or accounts for specific purposes.  If you are of that mindset, that’s ok.  You may find the Roth IRA to be a source of inspiration for funding a specific future goal for yourself or for others in your family.

Here are a few examples of how clients have compartmentalized their Roth IRAs:

  • Earmarking a Roth IRA to fund long-term care expenses
  • Drawing on a Roth IRA to pay education costs for a child or grandchild
  • Using Roth IRA funds to cover unbudgeted “emergency only” types of expenses
  • Spending Roth IRA funds for a milestone birthday, anniversary, or other special event

Having a special purpose for your Roth IRA may provide you with the proper motivation to continue contributions and conversions over time.

These are just a few tips to enhance your Roth IRA experience.  Your Fiduciary Investment Advisor can provide more direction on matters of timing and allocation.

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