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Avoiding Compounding Generational Debt

The US will be facing a retirement crisis starting with the millennial generation. While I do not like to scare people with information but this is something that you need to know and understand ASAP. The 2020 pandemic exposed a massive gap in financial knowledge and household goals. If you were relying on thing remaining the same for the next 40 years, you will be disappointed.

Boomers are slated to retire in waves ended around 2035. Those were under-prepared for the transitions will become burdens to their adult children. Those millennials will struggle with their debts, lack of savings and investments, and their own kids. With three generations under one roof, that is a recipe for a compounding generational debt cycle.

For millennials to retire at 65 and live on investment and retirement income of $100,000 a year, they would need to have $2.5 – $3 million invested. If that sound crazy to you, jot it down and put it on a time capsule for 2050. The landscape is change and it is imperative that you learn to change with it, as soon as today.

So What Is A Roth IRA? Traditional IRA? Limits Per Year?

There are several retirement account options available from 401ks, 403bs, 457bs, Traditional IRAs, Roth IRAs and even Health Saving Accounts. You can use either or a majority of these items at one time. If you contribute and/or max out your 401k plan, you can also contribute to an IRA. While the traditional version provides tax-deferred growth, ROTH IRA provide no taxes on capital gains and dividends. There are unique benefits to each.

When you can, you should try to contribute to a Roth IRA as part of your retirement savings strategy. The younger you are, the better the benefits will be over time.

Just remember that unlike employer plans with a limit of $19,500 for single under 50, and $26,000 for over 50, Roth IRA contributions are not tax deductible. You will not have to pay until you withdraw at age 59 ½ +.

There are Roth IRA rules that trigger with income and contribution limits of $6,000 that you need to follow in 2020 and 2021.

Best Features

Roth IRA Tax Benefits

Do not be alarmed, ROTH IRAs are funded with post tax contributions. You already paid FICA taxes upfront in your paycheck and now you are merely using your after-tax money to invest directly in the market. Once the money is in your ROTH and properly allocated, the account earnings grow tax-free. Any transaction initiated in a ROTH is also tax-free. Any Dividends earned, you guessed it tax-free for life.

Investing Style in a ROTH

In a ROTH IRA, you can select what you want to invest in such as stocks, bonds and mutual funds. This feature give you more lateral movement and decisions not offered by employer plans which tend to be more mutual funds or ETFs. This also means that you are taking on the management risk as well.

Borrowing for a Home with Your ROTH

Turns out, you can request a qualified distribution of up to $10,000 for buying or building your first home (up to your investment limit or restricted amount from your Brokerage).

No Minimum Required Distribution for ROTHs

There are no required minimum distributions for Roth IRA accounts. Employer plans and Traditional IRAs have required minimum distributions starting at 70 ½. If these plans were your only retirement strategy, that tax windfall at 71 would be high. Imaging having $500,000 in a 401k, and being hit with 30% taxes. That is a clean $150,000 to Uncle Sam.

This is where tax and investment planning intersects. There is no required minimum distribution beginning at 70 ½ with a Roth IRA. You can opt to pass this money onto your heirs to kick off generational wealth.

The Drawbacks

Try Not to Take Money from Your ROTH but if you must

I would never recommended that you borrow money from a ROTH IRA or any other retirement account however things happen in life that may for your hand. With a ROTH, you may have to pay a 10% penalty for an early withdrawal but there are a few exceptions:

During a ROTH IRA rollover from brokerage to brokerage, you can withdraw all or part of your money penalty-free, however
You must pay back the full amount in 60 days.

Losing Your ROTH Benefits

As are all good things, opportunity is a privilege. Misuse an opportunity and they are taken away. When you withdraw money from your Roth, you lose the tax benefits of those contributions earning capital gains and dividends tax-free.

The Later Stages

When can I make a Roth IRA Contribution Withdrawal?

With a Roth IRA, you are always able to withdraw your contributions penalty free. The distinction comes in play where you cannot withdraw our earnings. Therefore, if you invested $10,000 in a ROTH and it grew to $30,000, you can withdraw $10,000 at any time.

Ideally, you already paid taxes on the contributions. Therefore, you can withdraw those dollars. Withdrawing the earnings incurs the taxes or penalties.

Once you hit 59 ½, as long as you’ve held the account for at least five years, you can take distributions on all money within the account and do not have to pay taxes on that money.

Roth IRA Summary

It is important to start early with planning for savings and investments.

Having a firm understanding of the basics can help you formulate better questions about your retirement strategy. Take advantage of the tax benefits offered by your employer plans, IRAs and HSAs. Break the compounding generational debt cycle and shift into wealth building.

At 7% with a contribution of $6,000 annually in a ROTH for 40 years, that is over $1 Million but I will let the calculator do the work from here.