Roth IRAs have been around since 1997, but many people still have questions about how they work and whether they make sense for their retirement strategy. In this week’s episode of Retire in Texas, Darryl Lyons, CEO and Co-Founder of PAX Financial Group, unpacks the power of Roth IRAs and how they differ from traditional IRAs.
Show Highlights:
- The difference between marginal and effective tax rates – and why it matters for Roth contributions and conversions.
- Real stories of how retirees and pre-retirees have used Roth conversions to reduce future tax burdens.
- Key considerations before converting, including cash needs, Medicare IRMAA surcharges, and tax brackets.
- The impact of Roth IRAs on estate planning and how they can benefit the next generation.
- Contribution limits for 2025 and how Roth 401(k)s compare to Roth IRAs.
Whether you’re just starting out, approaching retirement, or thinking about legacy planning, this episode will give you practical insights into how a Roth IRA may fit into your overall financial plan.
If you enjoyed today’s episode, be sure to share it with a friend or family member!
Transcript:
Hey, this is Darryl Lyons, CEO and Co-Founder of PAX Financial Group. And you’re listening to Retire in Texas, where building wealth comes with clarity and purpose and peace, and we guide our thoughts by 1 Timothy [6:17] through 19. And I want to help you grow your wealth without losing your grounding. And if that’s what you’re after, you’re at the right place.
Thanks for listening to Retire in Texas. And remember, this information is general in nature only. It’s not intended to provide specific investment, tax, or legal advice. Visit PAXFinancialGroup.com for more information. So, here’s a story. This is on Motley Fool back in 2017. This is not me. This is somebody else saying the story. Back in 2017, my wife and I both opened Roth IRAs.
We challenged ourselves to contribute the maximum allowed each year. And now as of 2025, each of our accounts has grown to $109,299. So that’s $218,598 combined. Not bad for nine years of steady, disciplined investing. This isn’t about bragging. I’m sharing real numbers openly to show the true power of Roth IRAs. My goal is to inspire anyone who’s hesitant to start investing and building wealth, even if it’s with small amounts at first.
Now we are talking Roth IRAs. Today, and no matter what age you are, I want you to stay tuned in. You may say, well, you know, I missed that window. We are going to talk about some ways that Roths may be able to help you, even if you are pivoting or about to pivot. So, I remember Roths when they first came out.
It was 1997. I was undergraduate at Saint Mary’s University, and I was working at Bank of America, and we talked about opening up Roth accounts for our customers. And so, I got a VHS cassette, and I went home to my dorm and I watched the VHS explanation on Roth IRAs. And I’ll never forget being made fun of for doing that while all my buddies were having a good time.
So that’s my history with Roth IRAs developed by Senator William Roth out of Delaware, designed to help people save money and the benefit of Roth IRAs is that they’re tax free. So, in summary, they are different than traditional IRAs in the fact that traditional IRAs, you generally get a deduction for putting money in. But when you pull it out at retirement, you pay taxes.
Roth IRAs, on the other hand, thanks to Senator Roth out of Delaware, you put money in. You don’t get the deduction. But when you pull it out, if you do it right, it’s completely tax free. Just kind of a big deal. So, let’s kind of unpack this a little bit. And I’d like to start out just talking taxes for a second.
Because this can be confusing. And I think it’s worth kind of figuring this part out. So, there’s this thing called, you know, we have these tax brackets. There’s the marginal and effective tax rate. I think it’s worthy just to know the difference between the two, especially when you’re talking about Roth IRAs. So, the marginal rate is the rate on the last dollar earned.
So, in other words, if you’re in a bracket and you’ve often heard this a 24% tax bracket, that doesn’t mean all of your income is taxed at 24%. It’s just whatever that last dollar earned, it might have creeped into that next bracket. So, some people say I’m in the 24% tax bracket, or you might have heard of that before.
Again, that doesn’t mean that all of your money is taxed at 24%. It seems to me whenever I’ve looked at returns of most Americans that are just kind of in this middle upper class, most of them I look at, I see their tax return in their affective tax is between 14 and 17%. Their effective. So even if they might be in the marginal tax bracket of 24%, what they’re actually paying taxes is closer to 14 to 17% in that range after the deductions, whether it’s standard deduction, itemized deductions or above the line deductions.
And so, knowing this is important because Roth contributions and even something called conversions are all about paying taxes now when rates are lower than when they are higher down the road, or potentially higher. And that’s the trick, right, is that we don’t know with 100% certainty if they’re going to be higher down the road. So, we are making that assumption.
And that’s why it becomes very individualized on whether or not we do Roth contributions. And then something called conversions, which means we take those traditional IRAs, and we convert them to Roth IRAs. But let me give you a few, like, little stories, change the name for, say, you protect the innocent here, but, Bill, 60 years old, retired engineer, has about $700,000 in his IRA, by the way, IRAs, not individual retirement account, it’s individual retirement arrangement.
Just for those that are curious. But he has 700,000 in his IRA. It is a traditional IRA because it was a rollover. He rolled it over from his former employer, and he rolled it over from his 401k with his former employer. And all of those monies that he put in there were pretax. So, he rolled that over to a traditional IRA.
So now this 700,000 is all subject to tax. So, we notice that this was, he was kind of in this low income window because he had quit work and he had yet to start getting Social Security. And he had yet to start taking out required minimum distributions. So, he’s kind of in this, I’m unemployed retired kind of window.
Not a lot of income. So, with that opportunity in front of us, we did some conversions. And so, the idea is to convert 100,000 a year over a few years and pay taxes at, you know, low marginal rate and low effective rate. So that way down the road, he’s got a bucket of money, let’s say $300,000 depending on how much ultimately gets converted.
So, transition from a traditional to a Roth, a bucket of money completely tax free down the road. And those Roth IRA dollars aren’t subject to required minimum distribution. And so, we were very, the point I want to make in that, there may be some other questions that you have in your head. But the point I want to make is that we identified a window where his effective tax rate was going to be pretty low.
It’s like paying $2 a gas when the price is about to hit $5, and the price is about to hit $5, because he was going to get some social security, and he was going to have to start taking these required minimum distributions out of this traditional IRA. So, we knew the tax was going to go up in this case.
Now, we did set aside the, I know this degree of speculation about whether or not the government’s going to raise taxes, but we can talk about that later. But just in his situation, he forecast it out just using some technology that we use. Most advisors should use it to just say down the road, it looks like you’re going to have a higher tax bracket.
So can we convert now while you’re in this case, unemployed. The conversion thing. So, let’s kind of unpack that again. It’s a traditional IRA where you had pretax dollars in and you want to convert that over to a Roth because you believe that you’ll have less income in the future. Or some people have conviction that there’s going to be higher tax rates, which somebody’s got to pay for the government debt.
So that makes sense. But the other thing that you have to consider, or at least need to consider, I think two things. First of all, when you convert from a traditional to a Roth, you have to make sure you have cash to pay that tax because you’re going to pay tax immediately when you convert. So, $100,000 you convert to a Roth, you know, that could be 20 or $30,000 of cash that you’re going to have to write to the IRS because you’re paying that tax today.
That’s why the IRS still allows us to do this, because they need the money. So, you convert it today. So, I think it’s important for you to just keep in mind you have to have excess emergency funds, because that’s where it’s going to come from. And the other thing you want to be careful of is it could trigger something called a Medicare IRMAA.
This is for those that are getting Medicare so or may about are close to getting Medicare. You want to work with your advisor to make sure it doesn’t trigger something called a Medicare surtax. And so just something to be aware of. Again, your advisor can help you with this. So, you convert and just be careful. And or you may pay a surtax on Medicare and you’re just like, okay, at least I know about it.
But that’s something to just be sure to ask your advisor before you convert. Let me give me another example. So, Maria, 58, retired teacher, income close to zero for two years, converted about 80,000 from traditional IRA to a Roth and just let it cook, and just let it grow completely tax free. So that’s, and by the way, you can leave this to the next generation so it can be an inherited Roth IRA beneficiary.
They, I guess beneficiary Roth IRA is the right language, tax free to the next generation is pretty powerful. Now, they do have to take money out over a certain time frame. They recently changed the rules to a ten-year window. Used to be over their lifetime. So, it’s not as advantageous. But still it’s something to consider, especially if you’re interested in it and it’s kind of like but I guess if you convert for your kids, it’s kind of like you’re prepaying the tax for them.
So, it’s pretty nice thing I had some one guy the other day say why would I pay the taxes for my kids. They’re getting a bunch of money. They can pay it themselves. That’s absolutely true. But I think it’s worth exploring if you’re going to leave a Roth IRA to the next generation or leave an IRA to the next generation.
I think it’s worth exploring. Hey, is it worth it? I had a situation where the kids were doctors and they were making a ton of money, and it was I mean, it was going to be a pretty expensive inheritance. I mean, no one’s complaining, but it would have been advantageous to convert it today. Hey, maybe even the kids will pay the conversion tax.
I don’t know, I’ve never done that before. Let me give you another example. So, this is a bad example. So, Tom, 62, business owner, converted 900,000 of his IRA in one year and it pushed him into the highest tax bracket. And as a result, higher Medicare premiums. Like I talked about those Medicare surcharges. You can also get tax on Social Security more.
So, you just have to pay attention to how much to convert oftentimes we’ll convert up to the next bracket. It doesn’t kill you if you go into the higher bracket, because again, it’s only the last dollars go into that last bracket. But if you can plan, you can say, okay, I’m only going to convert this much this year because I’ll hit this bracket next year, I’ll convert this much.
That’s how you can strategically do it. And that, you know, that money adds up. The savings adds up. You got to pay attention to the limits. I think it’s important that you know, that you have the Roth limits, which are 7000. That’s the most you can put in. If you’re over 50, you can put in 8000.
But don’t forget some of you guys. And if you’re retired, make sure you tell your kids, a lot of 401ks now have an option that you could do a Roth 401k. This is huge and a lot of people are missing it. Tell your kids, tell your grandkids. If it’s not you, make sure they’re selecting the Roth option in there 401k.
Yes, they don’t get the deduction today, but they could put about $23,000 into there, I may be off. I think that might be 24 number. I’ll double check myself. But $23,000 into the Roth 401k growing completely tax free. Make sure they’re putting the money in. Make sure they’re maximizing it. Make sure they’re investing it well.
There are income limits. Not for the Roth 401k, no income limits for that. But income limits on the I don’t say traditional, on the Roth IRA, not the Roth 401k there are income limits on the Roth IRA and it kind of has this phase out thing. So just know if you’re single, if you make over 150,000, it begins to phase out on how much you can put in if you’re married, filing joint and you make over 236,000, that’s when the phase out begins.
And you won’t be able to put in the maximum amount. So just pay attention to those limits. You don’t want to mess that up. I was reading a Reddit article, and a guy was looking for help because he had messed up his Roth IRA, and go to Reddit for help. Okay. But he made too much money, so trying to figure out what to do.
I don’t have time to do it today, but there’s something called a backdoor Roth, something that you might want to look into. Don’t do it without working with an advisor because you can mess up. I messed up on one of those a long time ago. I won’t do it again. So, I learned from my mistake. But you can really mess those up, so be careful.
And again, make sure that you don’t convert too much where you go into different bracket, there’s also something, a five-year rule that you want to pay attention to. Again, I’m kind of keeping it high level, but things to think about. And then just think about, I would say last thing for you to think about is just what the legacy options might look like, because it’s kind of cool to be able to leave a Roth IRA to the next generation.
And then if you want to be really thoughtful about it, maybe you invest that a little bit more aggressively than you would your own personal money. So, there’s something to think about there. I really think this tax diversification idea makes a ton of sense. Both, you know, maybe have some tax free stuff, some taxable stuff. You know, you spread it out a little bit.
And that way when you run into different administrations that are trying to solve the government debt problems in different ways you can navigate and maybe take distributions from this account or not this one and so I think that puts you in a position of flexibility. But a Roth IRA has to be a part of the equation. And I find it to be just a very, very useful tool in a conversation that we have with nearly every single client today.
So, thanks for listening to Retire in Texas, I want you to continue to stay grounded, live generously and remember, you think different when you think long term. Have a great day.
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