By Jada Diedrich, CPA
Roth IRAs are a great way to build your retirement nest egg, help your kids learn financial responsibility, and save money on taxes. Before we dive deep into this popular investment strategy, let’s first examine the basics: When you make qualifying withdrawals from a Roth IRA, you pay no income taxes. The government allows you to contribute $6,000 ($7,000 if you are over 50) each year if your modified adjusted gross income (MAGI) in 2022 does not exceed $144,000 for a single taxpayer or $214,000 for a jointly filed couple amounts. If you reach this income bracket, you cannot make a direct Roth IRA contribution.
If your income exceeds these limits, are you out of luck? Not necessarily. Here are some planning opportunities that might open the door to Roth retirement planning for people who thought it was closed.
Does your company pension scheme have a Roth option?
Many companies have a Roth option in their 401(k) or other qualifying plans. If you don’t know, it’s worth asking. Income restrictions do not apply if you are contributing to an employer-qualified plan. With this strategy, contributions can be made after the age of 70 if you have an income from work.
If you are eligible to fund a Roth IRA, it may be in addition to contributing to your company pension plan. For example, in 2022, you can forward $20,500 ($27,000 if you are over 50) to your employer Roth or the traditional 401(k). In addition, you can make a $6,000 ($7,000 if you are over 50) Roth IRA contribution if you are within income limits.
Some plans allow you to make after-tax contributions into qualifying retirement plans. It’s possible to really take advantage of some savings opportunities if you have the cash flow to do it.
There are some aspects of your business plan that you should fully understand. For example, employer contributions do not go into the Roth portion of the plan but go into the traditional plan and are taxed when paid out. Be sure to speak to your Benefits Manager for a summary of your specific plan.
Have you heard of the “back door” Roth IRA?
This strategy is a two-step process where you make a non-deductible contribution to a traditional IRA (which has no income restrictions) and then convert it to a Roth IRA. If you do this immediately, there may be no tax consequences. The plan is a bit complex – especially if you have other IRA accounts (SEP, SIMPLE, etc.) – so consult a tax professional first to understand your specific situation. It is worth noting that there has been talk among legislators of scrapping this strategy. While this is currently still an option, it’s another good reason to consult a tax professional before attempting this method.
Other Roth conversion strategies
Another way to use Roth conversions is to convert existing traditional IRAs to Roth IRAs. While this results in normal income for the amount you’re converting, there are many scenarios — especially for new retirees who haven’t started collecting Social Security yet — where it could lower your taxes over time. Because you’re effectively reducing your traditional IRA value, the required minimum distributions (RMDs) on these accounts are lower. Also, Roth IRAs do not require minimum distributions, so this conversion strategy can help retirees control their taxable income in retirement. This can result in lower Medicare costs for the retiree because Medicare Part B premiums are based on your taxable retirement income.
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Roth IRA planning for children
When we see the benefit of tax-free growth over time, many wish we had started the Roth Savings Account sooner. There is no minimum age to fund a Roth IRA, only a requirement to have an earned income. For example, if you have children who work part-time jobs, they should consider funding a Roth IRA. Encourage them to put a portion of their income into their own Roth IRA, or you can gift them contributions on their behalf. As long as the contribution to Roth does not exceed your earned income, you can also “match” your contributions. These are all great ways to teach kids about saving and investing.
Let’s look at how much you can save over time if you start investing different amounts at different ages. Let’s assume the following:
- You want to retire at 65.
- The market gives an average return of 6%.
- You have a starting balance of $10,000 in your Roth IRA.
- You’re making $30,000 a year, so you’re sitting at a marginal tax rate of 12%.
Pay now or pay later
With the Roth old-age provision strategies, you pay taxes now and not later as with traditional old-age provision. Deciding which is better comes down to whether you think your income taxes will be higher in retirement than they are now. If your crystal ball is as cloudy as ours, you can opt for some of the two strategies regarding future tax rates. Also remember, if you have failed to make contributions in a given year, you have until April 15thth to be paid in the following year.
Whether you invest in a Roth or a traditional IRA, this retirement savings strategy is a great way to grow your money. It’s also a fun way to start your kids on the tax responsibility journey. As many factors can play a role in this wealth plan, it is best to consult your wealth advisor for more information.
About the author: Jada Diedrich, CPA
As a CPA and Buckingham Wealth Advisor, Jada Diedrich spends a great deal of time getting to know clients both personally and professionally. By building strong relationships, she improves her ability to help clients define and achieve their goals.
For informational and educational purposes only and should not be construed as specific investment, accounting, legal or tax advice. Certain information is based on data provided by third parties, which may become obsolete or otherwise replaced without prior notice. Third-party information is believed to be reliable, but its accuracy and completeness cannot be guaranteed. Individuals with special needs and those who care for them have unique circumstances and individuals should speak with a qualified professional based on their own circumstances. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency has approved, determined, or endorsed the accuracy of this article. R-22-3525
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