These Year-End Retirement Plan Adjustments Could Transform Your Wealth

You know you want to contribute more to your retirement plan. However, maybe you have heard vicious rumors that there are income limits, and you make too much money to contribute to a Roth IRA. Well, guess what? Christmas just came early! You can contribute to a Roth IRA through a conversion strategy.

I also want to introduce the strategy of “chunking.” The only caveat is, the deadline to take advantage of this strategy is Dec. 31.

Why does a Roth IRA make sense?

Many investors and financial professionals are familiar with the primary benefits of a Roth IRA: The plan’s investments grow tax-free and come out tax-free. But if tax-free investing isn’t enough to get you excited, rest assured, there are more benefits to Roth IRAs.

First, Roth IRAs are not subject to RMDs. Traditional retirement plan owners are subject to rules known as Required Minimum Distribution rules, which require the account owner to start taking distributions and paying tax on the distributions (since traditional plan) when the account owner reaches the age of 70-and-a-half. Not being subject to RMD rules allows the Roth IRA to keep accumulating tax-free income (free of capital gain or other taxes on its investment returns) and allows the account to continue to accumulate tax-free income during the account owner’s lifetime.

Second, a surviving spouse of a Roth IRA has special options. A spouse who is the beneficiary of a Roth IRA can continue contributing to that Roth IRA or can combine that Roth IRA into his or her own Roth IRA. Allowing the spouse beneficiary to take over the account allows additional tax-free growth on investments in the Roth IRA account.

Third, Roth IRA owners are not subject to the 10 percent early withdrawal penalty. This is for distributions taken before the age of 59-and-a-half on amounts comprised of contributions or conversions. Growth and earnings are subject to the early withdrawal penalty and taxes, too, but you can always take out the amounts you contributed to your Roth IRA or the amounts that you converted without paying taxes or penalties. (Note that conversions have a five-year waiting period before you can take out funds penalty and tax-free.)

The “back door” deadline: Dec. 31.

Roth IRAs can be established and funded for high-income earners by using what is known as the back door Roth IRA contribution method. Many high-income earners believe that they can’t contribute to a Roth IRA because they make too much money and/or because they participate in a company 401(k) plan. Fortunately, this thinking is wrong. While direct contributions to a Roth IRA are limited to taxpayers with income in excess of $129,000 ($191,000 for married taxpayers), those whose income exceeds these amounts may make annual contributions to a non-deductible traditional IRA and then convert those amounts to a Roth IRA.

The strategy used by high-income earners to make Roth IRA contributions involves the making of non-deductible contributions to a traditional IRA and then converting those funds in a non-deductible traditional IRA to a Roth IRA. This is often referred to as a back door Roth IRA. In the end, you don’t get a tax deduction for the amounts contributed, but the funds are held in a Roth IRA and grow and come out tax-free upon retirement (just like a Roth IRA).



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