7 Missed IRA Opportunities

Posted On March 31, 2019 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

Individual Retirement Account (IRA) is the cornerstone of retirement planning, yet so many people miss opportunities to fund an IRA because they don’t realize they are eligible. With the great tax benefits of IRAs, you might want to consider funding yours every year that you can. Here are seven situations where many people don’t realize they could fund an IRA.

1. Spousal IRA. Even if a spouse does not have any earned income, they are eligible to make a Traditional or Roth IRA contribution based on the household income. Generally, if one spouse is eligible for a Roth IRA, so is the non-working spouse. In some cases, the non-working spouse may be eligible for a Traditional IRA contribution even when their spouse is ineligible because they are covered by an employer plan and their income is too high.  

2. No employer sponsored retirement plan. If you are single and your employer does not offer a retirement plan (or if you are married and neither of you are covered by an employer plan), then there are NO income limits on a Traditional IRA. You are always eligible for the full contribution, regardless of your household income. Note that this eligibility is determined by your employer offering you a plan and your being eligible, and not your participation. If the plan is offered, but you choose not to participate, then you are considered covered by an employer plan, which is number 2:

3. Covered by a employer plan. Here’s where things get tricky. Anyone can make a Traditional IRA contribution regardless of your income, but there are rules about who can deduct their contribution. A tax-deductible contribution to your Traditional IRA is greatly preferred over a non-deductible contribution. If you cannot do the deductible contribution, but you can do a Roth IRA (number 4), never do a non-deductible contribution. Always choose the Roth over non-deductible. The limits listed below do not mean you cannot do a Traditional IRA, only that you cannot deduct the contributions.

If you are covered by your employer plan, including a 401(k), 403(b), SIMPLE IRA, pension, etc., you are still be eligible for a Traditional IRA if your Modified Adjusted Gross Income (MAGI) is below these levels for 2018:

  • Single: $63,000
  • Married filing jointly: $101,000 if you are covered by an employer plan
  • Married filing jointly: $189,000 if your spouse is covered at work but you are not (this second one is missed very frequently!)

Your Modified Adjusted Gross Income cannot be precisely determined until you are doing your taxes. Sometimes, there are taxpayers who assume they are not eligible based on their gross income, but would be eligible if they look at their MAGI.

4. Roth IRA. The Roth IRA has different income limits than the Traditional IRA, and these limits apply regardless of whether you are covered by an employer retirement plan or not. (2018 figures) 

  • Single: $120,000
  • Married filing jointly: $189,000

5. Back-door Roth IRA. If you make too much to contribute to a Roth IRA, and you do not have any Traditional IRAs, you might be able to do a “Back-Door Roth IRA”, which is a two step process of funding a non-deductible Traditional IRA and then doing a Roth Conversion. We’ve written about the Back Door Roth several times, including here.

6. Self-Employed. If you have any self-employment income, or receive a 1099 as an independent contractor, you may be eligible for a SEP-IRA on that income. This is on top of any 401(k) or other IRAs that you fund. It is possible for example, that you could put $18,500 into a 401(k) for Job A, But this is more like a series of popular online friv games than what is described above. contribute $5,500 into a Roth IRA, and still contribute to a SEP-IRA for self-employed Job B.

There are no income limits to a SEP contribution, but it is difficult to know how much you can contribute until you do your tax return. The basic formula is that you can contribute 20% of your net income, after you subtract your business expenses and one-half of the self-employment tax. The maximum contribution to a SEP is $55,000, and with such high limits, the SEP is essential for anyone who is looking to save more than the $5,500 limit to a Traditional or Roth IRA. 
Learn more about the SEP-IRA.

7. Tax Extension. For the Traditional and Roth IRA, you have to make your contribution by April 15 of the following year. If you do a tax extension, that’s fine, but the contributions are still due by April 15. However, the SEP IRA is the only IRA where you can make a contribution all the way until October 15, when you file an extension. 

Bonus #8: If you are over age 70 1/2, you generally cannot make Traditional IRA contributions any longer. However, if you continue to have earned income, you may still fund a Roth IRA after this age.

A few notes: For 2018, contribution limits for Roth and Traditional are $5,500 or $6,500 if over age 50. For 2019, this has been increased to $6,000 and $7,000. You become eligible for the catch-up contribution in the year you turn 50, so even if your birthday is December 31, you are considered 50 for the whole year. Most of these income limits have a phase-out, and I’ve listed the lowest level, so if your income is slightly above the limit, you may be eligible for a reduced contribution. 

Retirement Planning is our focus, so we welcome your IRA questions! We want to make sure you don’t miss an opportunity to fund an IRA each and every year that you are eligible. 

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Roth Conversions Under the New Tax Law

Posted On December 2, 2018 By Scott Stratton, CFP(R), CFA In Retirement Planning, Tax Strategies /  

Everybody loves free stuff, and investing, we love the tax-free growth offered by a Roth IRA. 2018 may be a good year to convert part of your Traditional IRA to Roth IRA, using a Roth Conversion. In a Roth Conversion, you move money from your Traditional IRA to a Roth IRA by paying income taxes on this amount. After it’s in the Roth, it grows tax-free.

Why do this in 2018? The new tax cuts this year have a sunset and will expire after 2025. While I’d love for Washington to extend these tax cuts, with our annual deficits exploding and total debt growing at an unprecedented rate, it seems unavoidable that we will have to raise taxes in the future. I have no idea when this might happen, but as the law stands today, the new tax rates will go back up in 2026.

That gives us a window of 8 years to do Roth conversions at a lower tax rate. In 2018, you may have a number of funds which are down, such as Value, or International stocks, or Emerging Markets. Perhaps you want to keep those positions as part of your diversified portfolio in the hope that they will recover in the future.

Having a combination of both lower tax rates for 2018 and some positions being down, means that converting your shares of a mutual fund or ETF will cost less today than it might in the future. You do not have to convert your entire Traditional IRA, you can choose how much you want to move to your Roth.

Who is a good candidate for a Roth Conversion?

1. You have enough cash available to pay the taxes this year on the amount you want to convert. If you are in the 22% tax bracket and want to convert $15,000, that will cost you $3,300 in additional taxes. That’s painful, but it saves your from having to pay taxes later, when the account has perhaps grown to $30,000 or $45,000. Think of a conversion as the opportunity to pre-pay your taxes today rather than defer for later.

2. You will be in the same or higher tax bracket in retirement. Consider what income level you will have in retirement. If you are planning to work after age 70 1/2 or have a lot of passive income that will continue, it is entirely possible you will stay in the same tax bracket. If you are going to be in a lower tax bracket, you would probably be better off not doing the conversion and waiting to take withdrawals after you are retired.

3. You don’t want or need to take Required Minimum Distributions and/or you plan to leave your IRA to your kids who are in the same or higher tax bracket as you. In other words, if you don’t even need your IRA for retirement income, doing a Roth Conversion will allow this account will grow tax-free. There are no RMDs for a Roth IRA. A Roth passes tax-free to your heirs.

One exception: if you plan to leave your IRA to a charity, do NOT do a Roth Conversion. A charity would not pay any taxes on receiving your Traditional IRA, so you are wasting your money if you do a conversion and then leave the Roth to a charity.

The smartest way to do a Roth Conversion is to make sure you stay within your current tax bracket. If you are in the 24% bracket and have another $13,000 that you could earn without going into the next bracket, then make sure your conversion stays under this amount. That’s why we want to talk about conversions in 2018, so you can use the 8 year window of lower taxes to make smaller conversions.

2018 Marginal Tax Brackets (this is based on your taxable income, in other words, after your standard or itemized deductions.)

Single Married filing Jointly
10% $0-$9,525 $0-$19,050
12% $9,526-$38,700 $19,501-$77,400
22% $38,701-$82,500 $77,401-$165,000
24% $82,501-$157,500 $165,001-$315,000
32% $157,501-$200,000 $315,001-$400,000
35% $200,001-$500,000 $400,001-$600,000
37% $500,001 or more $600,001 or more

On top of these taxes, remember that there is an additional 3.8% Medicare Surtax on investment income over $200,000 single, or $250,000 married. While the conversion is treated as ordinary income, not investment income, a conversion could cause other investment income to become subject to the 3.8% tax if the conversion pushes your total income above the $200,000 or $250,000 thresholds.

You used to be able to undo a Roth Conversion if you changed your mind, or if the fund went down. This was called a Recharacterization. This is no longer allowed as of 2018 under the new tax law. Now, when you make a Roth Conversion, it is permanent. So make sure you do your homework first!

Thinking about a Conversion? Want to reduce your future taxes and give yourself a pool of tax-free funds? Let’s look at your anticipated tax liability under the new tax brackets and see what makes sense your your situation. Email or call for a free consultation.

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Don’t Miss Out on a Roth IRA

Posted On January 25, 2017 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

I am a big fan of the Roth IRA and think it is an underutilized tool for investors. There are many people who are eligible for a Roth and are not participating. If you have a chance to put money into an account where it grows tax-free, why would you not want to contribute?

If you have a 401(k) at work, your first goal should be to maximize contributions to that account. For 2017, you can invest $18,000 into a 401(k), or $24,000 if you are age 50 or older. Your 401(k) contribution is tax deductible.

But whether or not you max out your 401(k) contributions, many families are missing the opportunity to also contribute to a Roth IRA. YES, you can be eligible for a Roth even if you participate in a retirement plan at work. More people should be trying to do both. Even if you do invest $18,000 a year into a 401(k), who says that will be enough to retire?

For the 2016 tax year, you can contribute $5,500 to a Roth IRA if your modified adjusted gross income (MAGI) is below $117,000 (single) or $184,000 (married). If you are over age 50, you can contribute $6,500. Contributions must be made by April 15, 2017 to count as a 2016 contribution.

Many investors are contributing to their 401(k) plan and say they don’t have additional income to contribute to an IRA. But if you have a taxable investment account, you could use money from that account to fund your Roth. If you aren’t planning to touch that money, don’t leave it in a taxable account, put it into an account that grows tax-free!

Here are a couple of important points to know about the Roth IRA:

  • With a Roth IRA, if you need to access your money before age 59 1/2, you can withdraw your principal (your original investment amount) without taxes or penalty. It is only if you withdraw earnings, would you be subject to a penalty and taxes before age 59 1/2, and even then only on the earnings portion.
  • If you’re married, as long as your income is below the $184,000 threshold, both or either spouse can contribute to the Roth IRA. It doesn’t matter if one spouse doesn’t work outside the home, you’re both eligible.
  • If you make too much to contribute to a Roth IRA, AND you do not have any Traditional IRAs, you may be a candidate to make a “Back-door Roth Contribution”. Read how here.
  • For investors who are over age 70 1/2, you are allowed to contribute to a Roth IRA but not a Traditional IRA. Again, put your money into the tax-free account if you are eligible!

The biggest problem with the Roth IRA is that the contribution limit is so low. When you miss a year of contributions, you can’t get that opportunity back later. So don’t miss out. If you are eligible for a Roth for 2016 and haven’t funded it, don’t delay. Call me today.

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Five Ways To Invest Tax-Free

Posted On February 29, 2016 By Admin In Financial Planning /  

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“It doesn’t matter how much you make, but how much you keep.” Over time, taxes can be a significant drag on returns, especially for those who are in the higher tax brackets. Today, many families are also hit with the 3.8% Medicare surtax on investment income. If you are in the top tax bracket, you could be paying as much as 43.4% (39.6% plus the 3.8% Medicare surtax) for interest income or short-term capital gains.

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The Secret Way to Contribute $35,000 to a Roth IRA

Posted On August 10, 2015 By Admin In Retirement Planning /  

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Roth IRAs are incredibly popular and for good reason: the ability to invest into an account for tax-free growth is a remarkable benefit. Unlike a Traditional IRA or Rollover IRA, there are no Required Minimum Distributions, and you can even leave a Roth IRA to your heirs without their owing any income tax. For retirement income planning, $100,000 in a Roth IRA is worth $100,000, whereas $100,000 in a Traditional IRA may only net $60,000 to $75,000 after you pay federal and state income taxes.

The only problem with the Roth IRA is that many investors make too much to be able to contribute and even those who can contribute are limited to only $5,500 this year. If you’re a regular reader of my blog, you may recall a number of posts about the “Back-Door Roth IRA”, which is funded by making a non-deductible Traditional IRA contribution and immediately making a Roth Conversion.

But there is another way to make much bigger Roth contributions that is brand new for 2015. Here it is: many 401(k) plans offer participants the ability to make after-tax contributions. Typically, you wouldn’t want to do this. You’d be better off making a tax-deductible contribution.

When you separate from service (retire, quit, or leave) and request a rollover, many 401(k) plans have the ability to send you two checks. One check will consist of your pre-tax contributions and all earnings, and the second check will consist of your after-tax contributions.

What can you do with these two checks? This was a gray area following a 2009 IRS rule. If the distributions were from an IRA, you would have to treat all distributions as pro-rata from all sources; i.e. each check would have the same percentage of pre-tax and after-tax money in it.

Remarkably, the IRS ruled in 2014 that when a 401(k) plan makes a full distribution, it can send two checks and each check will retain its unique character as a pre-tax or after-tax contribution. No pro-rata treatment is required. This will allow you to rollover the pre-tax money into a Traditional IRA and the after-tax money into a Roth IRA. This rule applies only when you make a full distribution with a trustee to trustee transfer.

Since this is a new rule for 2015, it is likely that your HR department, 401(k) provider, and CPA will have no idea what you are talking about, if you ask. Refer them to IRS Notice 2014-54. Or better yet, refer them to me and I can explain it in plain English!

Even though the salary deferral limit on a 401(k) is only $18,000, the total limit for 2015 is actually $53,000 or 100% of income. So you should first contribute $18,000 to your regular, pre-tax 401(k). Assuming there is no company match or catch-up, you could then contribute another $35,000 to the after-tax 401(k) to reach the $53,000 limit.

Let’s say you do this for five years and then retire or change jobs. At that point, you would have made $175,000 in after-tax contributions which could be converted into a Roth IRA, and since your cost basis was $175,000, there would be no tax due.

The earnings on the after-tax 401(k) contributions would be included with your other taxable sources of funds and rolled into a Traditional IRA. Only your original after-tax contributions will be rolled into the Roth account. Please note that this two-part rollover only works when you separate from service and request a FULL rollover. You may not elect this special treatment under a partial withdrawal or an in-service distribution.

Lastly, before attempting this strategy, make sure your 401(k) plan allows for after-tax contributions and will send separate checks for pre-tax and after-tax money. While this strategy is perfectly legal and now explicitly authorized by the IRS Notice, 401(k) plans are not required to allow after-tax contributions or to split distribution checks by sources. It’s up to each company and its plan administrator to determine what is allowed. The IRS Notice stipulates that this process is also acceptable for 403(b) and 457 plans, in addition to 401(k) plans.

Not sure if this works with your 401(k)? Call me and I will review your plan documents, enrollment and distribution forms, and call your plan administrators to verify. I think this would be a great approach for someone who is a handful of years away from retirement who wanted to stuff as much as possible into retirement accounts. Additionally, anyone who has the means to contribute more than $18,000 to their 401(k) each year might also want to consider if making these after-tax contributions would be a smart way to fund a significant Roth IRA.

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