For 2015, the IRS has announced that contribution limits will increase for a number of retirement plan types. For 401(k) and 403(b) plans, the annual contribution limit has been increased from $17,500 to $18,000. The catch-up amount for investors over age 50 has increased from $5,500 to $6,000, so the new effective limit for participants over 50 is now $24,000. Be sure to contact your HR department to increase your withholding in January, if you are able to afford the higher amount.
Traditional and Roth IRA contribution limits will remain at $5,500, or $6,500 if over age 50. SIMPLE IRA participants will see a bump from $12,000 to $12,500, and SEP IRA contribution limits are increased from $52,000 to $53,000 for 2015.
If you’re not sure where to start, here are my five recommendations, in order, for funding retirement accounts.
1) Choose the Traditional Plan
More and more employers offer Roth options in their 401(k) plans, but I believe the most investors are better off in the traditional, pre-tax plan. The only way the Roth is preferable is if your marginal tax rate is higher in retirement than it is today. The reality is that your income will probably be lower in retirement than when you are working. Even if your income remains the same 20 years from now, it is likely that tax-brackets will have shifted up for inflation and you may be in a lower tax rate. Lastly, there has been continued talk of tax simplification, which would reduce tax breaks and potentially lower marginal tax rates, which would also be negative for Roth holders. So, my advice is to take the tax break today and stick with the pre-tax, regular 401(k).
2) Maximize Employer Plan Contributions
Your first course of action will always be to maximize your contributions to your employer plan. Many individuals do this, but I’m surprised that with many couples, the lower paid spouse often does not. If you’re being taxed jointly, every dollar contributed reduces your taxes at your marginal rate. And don’t forget that since 2013, on income over $250,000, couples are subject to an additional 0.9% tax on Earned Income and an additional 3.8% on Investment Income to provide additional revenue to Medicare. Add the 3.8% Medicare Tax to the top rate of 39.6%, and you could be paying as much as 43.4% tax on your investment income. That’s a big incentive to maximize your pre-tax contributions as much as you can.
3) Traditional IRA, if deductible
If you maximize your employer contributions for 2015, and are able to do more, here is your next step: If your modified adjusted gross income is under $61,000 single ($98,000 married), then you can also contribute to a Traditional IRA and deduct your contribution. If your spouse is covered by an employer plan but you are not, the income limit is $183,000. This opportunity is frequently missed by couples, especially when one spouse does not work outside the home.
And of course, if neither spouse is covered by an employer retirement plan, both can contribute to a deductible Traditional IRA, without any income restrictions.
4) Roth IRA
If you make above the amounts in step 2, but under $116,000 single, or $183,000 joint, you are eligible to contribute to a Roth IRA. If your income is above these amounts, you would not be eligible to directly contribute to a Roth IRA. However, if either spouse does not have a Traditional IRA (including SEP or SIMPLE), he or she would be able to fund a “Back-Door Roth IRA”. This is done by contributing to a non-deductible IRA and then immediately converting to a Roth. Since there are no gains on the conversion, the event creates no tax.
5) Self Employment
If you have any 1099 income, are self-employed, or work as an independent contractor, you would also be able to contribute to a SEP IRA in addition to funding a 401(k). You can contribute to both accounts, subject to a combined limit of $53,000, if you have both W-2 and 1099 Income.
One option I’ve not seen discussed often is that someone who is self-employed could also fund a SEP and convert it to a Roth. If you don’t have any other Traditional IRAs, this could, in theory, be used to fund a Roth with up to $53,000 a year. The conversion would be a taxable event, but it would be cancelled out by the deduction for the SEP contribution.
There are quite a few variations and details in terms of eligibility for each family. Want to make sure you’re taking advantage of every opportunity you can? Give me a call to schedule your free planning meeting.