We are hearing clients ask the question “How can I get more money in a Roth account?” Many worry that it is too late or that their income is too high to be able to contribute to a Roth IRA.
So – is it too late? Have you missed the opportunity to get money into a Roth account? In this article we will explain why it is not too late – and how you can move money into a Roth in a tax efficient manner.
The fact is that in today’s environment, it makes perfect sense why everyone is asking about Roth accounts. When you look ahead to the next 5, 10, 20+ years, do you think taxes will go up, or stay the same? Of course, it is hard to not imagine tax rates increasing over the long term. We may even see taxes increase in the short term. The tax increases will disproportionately affect high income earners so if you are a high earner, there is no better time than now to plan to maximize your Roth accounts.
A Roth is a retirement account where contributions are made after tax which enables the withdrawals to be tax free. Contributions to a Roth account are after-tax, unlike Traditional IRA’s or Pre-tax 401k contributions. Ideally, in retirement you will have multiple “tax buckets” to draw from – tax deferred (traditional/rollover IRA’s), taxable (non-retirement), and tax free (Roth). This is called tax diversification. With tax diversification you will be able to reduce your taxes in retirement with proper planning.
Roth for High Earners via a 401k or Backdoor Roth IRA
The maximum contribution to a Roth IRA in 2021 is $6,000 ($7,000 if you’re age 50 or older). There is also a maximum income that you are allowed to earn and still be able to contribute to a Roth IRA: for taxpayers filing single your Modified Adjusted Gross Income (MAGI) must be under $140,000 in 2021 and for those married filing jointly, your MAGI must be under $208,000.If you are over the income limits, you will not be able to contribute directly to a Roth IRA.
However, there are no income limits that prevent you from contributing to a Roth 401k. If your employer offers a Roth 401k, you may want to consider allocating a portion of your contributions to the Roth. Since you are a high earner, the pre-tax contributions are also attractive. It may make sense to split up your contribution so that you are contributing to both the pre-tax and Roth 401k.
Even if your employer does not offer a Roth 401k, there is still another great option for getting money into a Roth account. It’s called the backdoor Roth IRA. We have already written an article that goes in depth on the backdoor Roth strategy so we will not go into detail in this article. Word of caution: we have seen many investors who attempt to do a backdoor Roth IRA without consulting their advisor or tax preparer and they make a mistake. The backdoor Roth IRA does not fit everyone, so it is important to get good advice from a fiduciary financial advisor if you have not done it before.
Roth for Employees via the Mega Backdoor Roth IRA
In addition to having a name straight out of a comicbook, the Mega Backdoor Roth IRA strategy can be very powerful if you are eligible. We have already touched on allocating some of your 401k contributions to the Roth 401k. For some employees, this is not the only way to move money to a Roth. If your employer’s 401k plan allows it, you may be able to make after-tax (post-tax) contributions. The earnings on after-tax contributions are taxable, so after-tax contributions are not nearly as attractive as Roth contributions. However, there is one additional step that can move your after-tax contributions to a Roth IRA. If your 401k plan allows, it you can make an in-service distribution of these after-tax contributions – meaning a distribution from your retirement plan while you are still working. If you are eligible to make an in-service distribution of the after-tax contribution, then the after-tax money could be rolled over to a Roth IRA and the earnings on those after-tax contributions could be rolled over to a rollover IRA.
Roth for Retirees or Almost Retirees via Partial Roth Conversions
Many people in retirement or nearing retirement are kicking themselves, regretting that they did not invest in a Roth IRA or Roth 401k earlier in their career. Now that they are in (or approaching) retirement, they are well aware of the tax implications of drawing down their tax deferred investment accounts. But don’t worry, there is still a great solution for you to be able to get money into a Roth account.
A Roth conversion is when an investor moves money from a pre-tax retirement account to Roth. This is a taxable event, and the amount moved is taxed at ordinary income tax rates. Timing is everything with this strategy, called “Partial Roth Conversions.” During your working years, your income is typically higher than in retirement, which means that your tax rate is lower in retirement. So, once you retire you have an opportunity to do partial roth conversions at a lower tax rate. Once you reach age 72, you are required to start pulling money from your tax deferred retirement accounts (Required Minimum Distributions, or RMD’s) which will cause your tax rate to increase again. So, you have a window between your retirement age and your age 72 to make partial roth conversions “at a discount”.
It is important to consult with your tax professional and fiduciary financial advisor to plan this properly.
In conclusion, we have walked through various ways to move money to a Roth no matter your age or if you are still working or retired. The bottom line is that with creative and intentional planning you can create tax free income in retirement. Be sure to consult with your fiduciary financial advisor to accomplish these strategies – who knows if you are lucky you may even find a fiduciary financial advisor who is also a CPA!
Wesley Botto is a financial consultant located at Botto Financial, 4565 East Galbraith Road, Suite B, Cincinnati, OH 45236. He offers advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, a Registered Investment Adviser. He can be reached at 513.924.3350 or at firstname.lastname@example.org.