Turn Your Roth IRA Into a Super-Roth
You may have heard from time to time about the importance of having tax diversification in your portfolio.
By splitting your money into pre-tax accounts and post-tax brokerage accounts, which may qualify for special capital gains tax treatment when sold, you’ll find some distinct potential advantages when it comes time to withdraw that money. But perhaps the greatest advantage of all could come from post-tax monies in Roth IRAs and Roth 401(k)s which may produce tax-free withdrawals and tax free income in retirement. When you blend the tax treatment on distributions from different types of retirement accounts, wealthy and even not-so-wealthy retirees and their heirs may enjoy significant benefits from having a Roth.
The problem for some people, though, is the $203,000 income limit for married couples filing jointly, which takes away their ability to contribute directly to a Roth IRA. That’s where the not-so-well-known Backdoor Roth IRA can come in handy.
Here’s how it works: Anyone who is under RMD age and has earned income can contribute to a non-deductible traditional IRA, then turn around and convert it to a Roth. The annual contribution limit, though, is relatively small – $6,000 for those under age 50 and $7,000 for those 50 or older. Plus, if you have any pre-tax money in an existing IRA or IRA Rollover from prior 401(k)s, and you want to do a Roth conversion, you can’t simply slice off the post-tax money and convert it… the after-tax and pre-tax money would have to be accounted for on a pro-rata basis.
But here’s a little secret: there’s actually a way to potentially get around these pro-rata rules. Some employers allow participants in their 401(k) plans to make after-tax contributions. And the limits are much higher than the traditional pre-tax contributions – $56,000 of total contributions in 2019. So let’s say you’re a highly-compensated 45-year-old, working for a company that has a 401(k) that offers a 50% match on the first $6,000 in contributions, AND allows post-tax 401(k) deposits up to the maximum. If you really wanted to turbo-charge your retirement, you could not only max out your deferral limit of $19,000 into the 401(k) and take the $3,000 company match, but you could also contribute an additional $34,000 of after-tax money into the 401(k) plan as well. These additional after-tax contributions do need to go to the “traditional” 401(k) and are not allowed to be put into a Roth 401(k).
If you did this for the next 10 years, you would’ve contributed a total of $340,000 in after-tax payments to the 401(k). If the account had earnings, they would be tax deferred and eventually taxed when withdrawn, but once you retire or sever employment with that company, you could do a direct rollover of the $340,000 in after-tax contributions to a Roth IRA and then roll all of the pre-tax contributions and earnings into a traditional IRA. Just like that, you’ve super-funded your Roth.
The Roth 2-Step and Super-Backdoor Roth strategies are certainly not for everyone, nor is any sophisticated retirement approach for that matter. But these and many other retirement strategies may help you get the tax diversification you need. This is exactly why you should get in touch with us here at Lucia Capital Group. We think about and implement strategies like that every single day. Give us a call – we’re here to help.
The information provided should not be considered specific tax, legal, or investment advice and is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. This material was gathered from sources believed to be reliable, however, its accuracy cannot be guaranteed.
Roth IRA distributions of principal from a Roth IRA are tax-free; however, any earnings will be taxed at ordinary income rates and a 10% penalty tax will apply if withdrawn prior to age 59½ or within five years of the date the Roth IRA was established, whichever is longer.
IRA withdrawals will be taxed at ordinary income rates. Withdrawals prior to age 59½ may also be subject to a 10% penalty tax.
Different types of investments and/or investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy (including the investments purchased and/or investment strategies devised by LCG) will be either suitable or profitable for a client's or prospective client's portfolio, thus, investments may result in a loss of principal. Accordingly, no client or prospective client should assume that the presentation (or any component thereof) serves as the receipt of, or a substitute for, personalized advice from LCG or from any other investment professional.
Rick Plum is a registered representative of, and offer securities through, Lucia Securities, LLC, a registered broker/dealer, member FINRA/SIPC. Advisory services offered through Lucia Capital Group, a registered investment advisor, and an affiliate of Lucia Securities, LLC. Registration with the SEC does not imply a certain level of skill or training.