Lately, I’ve been thinking a lot about how my various retirement accounts will affect my future income, specifically the taxes I’ll have to pay. That’s because my investments are spread among the three basic account types: taxable brokerages, tax-deferred or traditional retirement accounts, and tax-free or Roth retirement accounts.
Since I’m self-employed and always have a hefty tax bill, I’ve enjoyed making deductible SEP IRA contributions that significantly reduce my taxable income for many years.
However, as that tax-deferred account grows, it’s a reminder that I’m simply delaying an inevitable tax bill.
Roth IRA’s Contributions for High Earners
When I withdraw voluntarily and eventually get forced to take required minimum distributions (RMDs) from my tax-deferred accounts, taxes will catch up with me. That is unless I make some strategic moves ahead of time.
While it won’t be true for everyone, I believe my income tax rate will likely be higher in the future than it is today. That’s because I’ll have fewer tax deductions and will likely continue earning an income well into my “retired” years.
So, instead of keeping most of my retirement funds in a tax-deferred bucket, I plan to shift most of it to a Roth IRA over multiple years down the road. And that’s the case even though I’m technically too “rich” to qualify for Roth IRA contributions.
If you’re wondering how that’s possible or want to boost your Roth account, stay with me. This article will explain Roth IRA benefits, rules, and, most importantly, ways to boost a Roth IRA even if you’re like me and aren’t eligible for one.
What is a Roth IRA?
First, here’s a quick Roth IRA review. If you’ve been listening to the Money Girl podcast, you probably know that it’s a retirement account for individuals that requires nondeductible (after-tax) contributions. The tax goodness comes in retirement because it allows tax-free withdrawals if you’ve owned the account for at least five years and are over age 59.5.
Plus, you can withdraw your original Roth IRA contributions before age 59.5 penalty-free because they were previously taxed. However, taking earnings from a Roth IRA would be subject to income tax and an additional 10% penalty if you are younger than 59.5. That means you get a lot of flexibility with a Roth IRA, which isn’t possible with other retirement accounts.
For 2023, the maximum IRA contribution is $6,500 or $7,500 if you’re over 50. And you can make IRA contributions if you have earned income, no matter your age, up to your tax filing deadline for the prior year. (Need more information? Check out 10 IRA Facts Everyone Should Know)
Who qualifies for a Roth IRA?
Since a Roth IRA offers many excellent benefits, the rules were created to shut out high-earners. If you exceed an annual threshold, you’re considered too “rich” and become ineligible for regular “front door” contributions. And by the front door, I mean directly contributing to a Roth IRA using an after-tax source, such as your checking or savings account.
For 2023, the Roth IRA income cutoff for singles happens when you have a modified adjusted gross income (MAGI) of $153,000 or above. And married couples filing joint taxes can’t contribute when their household MAGI is $228,000 or above. But I’ll explain ways to get around the income thresholds and legally boost your Roth funds anyway!
Note that if you have a Roth at work, such as a Roth 401(k) or 403(b), income limits don’t apply. There are no income thresholds to qualify for a Roth at work, which is why I always encourage you to use it for all or a portion of your retirement contributions when it’s available. The long-term tax benefits of a Roth are just too darn good to pass up.
When is the Roth 410(k) right for you? Money Girl’s Laura Adams lets you know in episode 764 of the podcast.
What are Roth IRA benefits in retirement?
I mentioned that I plan on shifting much of my traditional retirement money to a Roth IRA. Let me explain if you’re wondering why I’m so enthusiastic about boosting a Roth.
A huge tax advantage of a Roth is that, unlike traditional retirement accounts, they have no RMDs at any age. You can take tax-free money out as needed or let it grow tax-free for you or your heirs. That could ultimately save a bundle in taxes, especially if the account value grows substantially over the long term.
By eliminating RMDs, you, not the IRS, have control over when and how much to take
out of your account in retirement. Plus, tax-free income allows you to keep and spend more of your hard-earned money in retirement, when you likely need or want every penny, instead of handing over a chunk to the government.
For example, if you’re single with a taxable income of $80,000 for 2023, you’re in the 22% tax bracket. But if you’re a great saver and accumulate a healthy nest egg, your voluntary or required minimum distributions starting at age 73 (or 75 beginning in 2033) could be $100,000, pushing you into the 24% tax bracket.
If you want to cut your taxes and save more for a secure future, check out this episode of Money Girl to learn more about Roth-related retirement updates.
Depending on the size of your traditional retirement accounts, RMDs for super savers could be hundreds of thousands of dollars per year. That means paying lots of income tax at your highest marginal tax rate for RMDs, and any other income like pensions and annuities. Additionally, having more taxable income strains your benefits because it may trigger taxes on most of your Social Security income and increase your monthly Medicare costs.
Even if your income in retirement won’t be higher than today, you might strongly believe tax rates for all Americans will rise in the future. Or perhaps you don’t want the hassle of paying income taxes to the federal and state governments (depending on where you live) on your future retirement income.
Those situations or beliefs are reasons to favor putting as much money as possible into tax-free Roth accounts. However, if you expect your retirement tax rate to be lower, using a Roth may not be wise because you’d pay more taxes today than in the future. While you can’t control the financial markets, you can manage your tax bill with sound strategies and planning.
3 Legal Ways to Boost Your Roth IRA Balance
What can you do if you want to make Roth contributions but don’t have a Roth retirement plan at work or are self-employed and earn too much? Well, let’s review three legal ways to boost a Roth IRA.
1. Max out a Roth IRA when you qualify.
If your income is below the 2023 Roth IRA thresholds, MAGI of $153,000 for singles and $228,000 for married joint tax filers, you can partially or fully max one out. I said “partially” because there’s a phase-out range below the thresholds when you can contribute less than the maximum.
The 2023 Roth IRA income limits are higher than in previous years, so look at it or consult with a tax pro toward the end of the year. Assuming you’re ineligible could mean missing a Roth opportunity.
Remember that if your income dips for any reason, such as getting laid off, not receiving a bonus, or having a less profitable business or side gig, you might qualify for a Roth IRA. And if your income increases above the threshold in future years, you won’t be allowed to make “front door” contributions.
While Roth IRA contribution limits are relatively low, every little bit helps boost your balance. Over time, that can add up to significant growth by the time you need to tap the account in retirement.
2. Make backdoor Roth IRA contributions.
Everyone qualifies to make backdoor Roth IRA contributions from after-tax funds you first contribute to a traditional IRA. You typically make pre-tax contributions to a traditional IRA–but nondeductible, after-tax contributions are also allowed. And it works for high-earners because a traditional IRA has no income limit; a Roth IRA is the only retirement account with income limits.
You make a nondeductible (after-tax) contribution to a traditional IRA and then roll it over to a Roth IRA. Since you pay tax upfront, no additional tax is due when moved to a Roth. However, the annual contribution limits, $6,500 or $7,500 if you’re over 50, still apply.
So, a backdoor Roth is a legitimate way to move small amounts of after-tax money from a traditional IRA to a Roth IRA, even if you earn too much for front-door contributions.
If you put after-tax money in a pre-tax account, you must file IRS Form 8606, Nondeductible IRA, to keep up with which funds in the account are taxable and nontaxable.
But you don’t owe taxes on backdoor contributions, except on any investment growth earned between the time of your nondeductible traditional IRA contribution and the Roth rollover. If you do it quickly, your earnings and resulting income tax should be small.
However, there’s a big backdoor downside if you already have a traditional IRA with pre-tax funds called the pro-rata rule. It requires you to lump all your IRAs together when you make a distribution and doesn’t allow you to cherry-pick one account to convert.
In the following podcast episode, Laura answers a listener’s question about the differences between a Roth IRA and a Roth offered at work. Listen to learn the updated rules and whether a traditional or Roth is best for you.
The bottom line is that backdoor Roth contributions work best if you have no pre-tax IRA balances. Otherwise, a portion becomes a taxable conversion based on the percentage of your nondeductible and deductible IRA balances.
There is a potential workaround to eliminate the pre-tax conflict if you have a retirement plan at work, such as a 401(k), that allows incoming rollovers. In theory, you could roll over pre-tax IRA funds into it. Or, if you’re self-employed, you could move pre-tax IRA money into a SEP IRA or solo 401(k) that allows it.
As always, speaking to a tax pro or financial advisor before making big retirement account moves is best. Get guidance on whether paying taxes now is worthwhile in exchange for future tax-free Roth benefits.
Again, if you don’t have any pre-tax IRA funds, you could move any amount (up to the annual contribution limit) from a nondeductible IRA for a backdoor Roth IRA contribution without triggering taxes. (And you can learn more with Your Complete Guide to 401(k) Retirement Accounts)
3. Do Roth IRA conversions.
A Roth IRA conversion differs from a contribution because funds come from a pre-tax source, such as a traditional IRA, 401(k), or SEP IRA, instead of an after-tax source. That means doing a Roth conversion triggers income taxes you must be prepared to pay.
Another difference is that unlike Roth IRA contributions, which come with an income limit, Roth conversions have no income limit. Additionally, Roth conversions have no contribution limit. You can convert as much as you like from traditional to Roth accounts each year, and the IRS will happily take your income taxes, no matter how much you earn!
For example, if you want to convert $50,000 from your traditional IRA to your Roth IRA, your annual taxable income increases by $50,000, increasing your tax liability. If you’re in the 22% tax bracket, you’d owe up to $11,000 on the conversion–but it could be more if the extra income pushes you into the next higher tax bracket.
That’s why it’s wise to do Roth conversions when you have a lower-income year and even when the value of your investments is down. Many people do conversions in the so-called “gap” years after they retire and earn less but before their RMDs begin.
Also, paying taxes on a Roth conversion from a non-retirement account, such as savings or a brokerage, is best to maximize the amount going to the Roth. Remember that if you’re younger than 59.5, you can’t use converted funds to pay taxes without paying an additional 10% early withdrawal penalty.
Everyone’s situation and retirement plans are different, so you should seek guidance from a financial advisor or tax professional before converting because you can’t reverse them if you change your mind.
Knowing if a Roth conversion is right for your situation depends on many factors, including the expected future benefits for you, a surviving spouse, beneficiaries, or charities you leave money to.
While you can’t be 100% sure, you should be very confident that your tax rate in retirement will be higher than today and that you have the cash to pay federal and any applicable state conversion taxes.
This article originally appeared on QuickandDirtyTips.com and was syndicated by MediaFeed.org.
Are my retirement goals realistic?
The median retirement account balance for all working Americans is $0, and half of those households are over age 55 (not a typo). But it’s not just a problem for the Boomers. Research has also uncovered that 95% of Millennials are not saving enough for retirement. (Also not a typo.)
It’s a bleak picture, to be sure. But when reality hits hard, motivation can follow. And no one wants retirement to just become one of those things that our parents and grandparents used to enjoy, back in the day.
On average, Americans spend 20 years in retirement. If you earn $75,000 a year when you retire and want to keep the same salary, you’ll need a total of $1.5 million squirreled away.
This is the part where many people might utter the word “impossible.” But if you start saving for retirement now, and make your retirement contributions just as mandatory as your electric bill, that number can start to look a little less intimidating.
In fact, just using a retirement calculator can put you in a better position than many Americans — fewer than half of them have done the math. And once you have your own enormous number, it can get easier to break it down into smaller, more attainable goals along the way.
To be sure, though, the road to retirement is paved with homework and sacrifice. It’s estimated people need 70% to 90% of their pre-retirement income to maintain the same standard of living after they stop working.
So perhaps more than any other financial decision you’ll make, reaching personal retirement goals takes diligence, preparation, planning for the “what if’s” and lots of willpower.
It may seem overwhelming, but it can help to start by determining your retirement objectives. Then you can find your own personal way to crush them. Everyone’s financial situation is different, and this plan is not the only solution out there, but here is one possible way you might go about determining your goals.
Halfpoint / iStock
One step you can take to determine your future is to get a solid picture of your present — somewhat like a personal audit. A careful inventory of your current expenses, income, taxes and savings can give you an honest picture of where you are, as well as a realistic look at where your money is going each month.
Once you’ve determined your day-to-day financial picture, you can create a list of any current retirement savings you already have, such as 401(k) accounts, IRAs, or high-yield savings accounts. Total up that number, because you’ll be able to subtract it from your goal.
monkeybusinessimages/istockphoto
A retirement calculator can help you figure out your overall, 20-year lump sum goal by working with variables such as your current age, salary and savings, your desired retirement age and how much you save per year.
Here’s where you can change up the numbers and consider several scenarios. If you were to retire at 67, for example, how much money will you need? What would happen if you were able to up your yearly savings by just 3%? You might even calculate the amount of money you’d need to save to retire early.
DepositPhotos.com
Take a deep breath. Then plan on.
fizkes / istockphoto
One possibly helpful way to tackle anything large is to break it down into digestible chunks. To do this, you could subtract your current age from your intended retirement age, then divide that number by the total. That’s your yearly goal. If it’s still overwhelming, you might divide that number by 12 for your monthly goal. Go as far as you need to make it palatable — those “for as little as 3 dollars a day” commercials make it sound easy, right?
For example, if your total number is $800,000 and you’re 30 years from retirement, that breaks down to around $75 a day. But that doesn’t mean you have to put that much into the bank by yourself. A next step you could take is finding the retirement savings plans that will do the most to grow your money.
Depositphotos
With the drastic decline in the traditional, company-provided pension and the uncertain future of Social Security, a number of different individual retirement savings plans, each with specific benefits, have stepped in to take their place.
If your employer offers a 401(k) matching plan, one of the easiest ways to grow your retirement nest egg is to contribute the max amount of money each paycheck that your employer is willing to match.
The contributions are automatically deducted from your paycheck pre-tax, and since you never see the money, it can be much easier to just pretend like it was never there to begin with.
For the self-employed, or for diversification, traditional or Roth IRAs are also specifically designed to help your savings grow.
The biggest advantages of 401(k) and IRA plans are their potential tax savings. However, they can come with yearly contribution limits that don’t mesh with your retirement objectives.
In this case, a general investment account is another possible consideration for growing your wealth. While it likely doesn’t come with tax advantages, it doesn’t come with contribution limits, either.
If investing in the market leaves you feeling wary, or you don’t like the idea of not having access to your money until you reach a certain age, another option to consider is a high-yield savings account.
It’s a cash-based account that has as much flexibility as a regular checking or savings account, but instead of the paltry 0.09% interest offered by some traditional banks, your money can potentially earn 2% or more.
gmast3r / istockphoto
You’ve calculated your retirement goal. You’ve determined a plan to reach it. And now it’s time for arguably the hardest part — sticking to the plan.
For as many investment or retirement accounts as possible, you might consider setting up automatic contributions to withdraw every payday. The more you can automate, the less you’ll be tempted to move things around.
Learn more:
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
SoFi Invest
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA/SIPC. The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
monkeybusinessimages / istockphoto
Featured Image Credit: Deposit Photos.
