You’ve read my last piece on the new tax codes and why a Roth might be a good option, decided a Roth is right for you, and now you want to know how to contribute to your Roth. Here are 6 ways to maximize your Roth retirement accounts:
1. Open and contribute to a Roth IRA. As long as your Modified Adjusted Gross Income (MAGI) is below the income limits ($120,000 Single/HoH filer, and $189,000 Married Filing Jointly) tax payers with earned income can contribute $5,500 annually to a Roth IRA. If you are age 50 or older you can make an additional $1,000 catch-up contribution for a total annual contribution of $6,500. If your spouse doesn’t work, you can still make a spousal Roth IRA contribution to their Roth IRA utilizing your earned income.
2. Use your workplace retirement plan. According to a Transamerica study, 52% of plan sponsors offer a Roth 401(k). Chances are your employer offers a Roth 401(k), Roth 403(b), or Roth 457(b) plan. These workplace retirement plans are not subject to income limits, so you can contribute $18,500 per year plus a catch-up contribution of $6,000 for anyone over the age of 50, regardless of income. You will want to note that these contribution limits are inclusive of, not in addition to, Traditional 401(k) contributions. So, for example, if you were already contributing $10,000 to your Traditional 401(k), you would only be able contribute an additional $8,500 to the Roth 401(k) before hitting the max contribution limit of $18,500.
3. Shift from taxable brokerage or bank accounts to a ROTH annually, to move from taxable to tax-free. I often meet retirement savers who started a Roth IRA but have stopped contributing due to cash flow constraints. These same savers will often also have money in bank accounts or taxable investment accounts. Even if they don’t have the cash flow to contribute to their Roth IRA, it usually makes sense to transfer funds from their taxable investment accounts or bank accounts to maximize the Roth IRA annually. This shifts assets from an account where tax is paid annually based on dividends, interest, and realized gains to an account that grows tax-free.
4. Convert assets from Traditional to Roth. The tax code allows you to shift an unlimited amount of assets from Traditional IRAs to Roth IRAs, regardless of income. The catch is you will pay tax in the year of conversion at ordinary income rates. You would only want to make conversions if you believe you will be in a lower tax bracket in the year of conversion than you would in the future. There is often a gap between retirement age and age 70.5 (when Required Minimum Distributions (RMDs) start) when retirees can convert assets to Roth at a lower tax rate. Many workplace retirement plans also allow for in-plan conversions, so check with your employer to see if that is an option for you. You should also note the ability to re-characterize (undo) Roth conversions after 2018 was removed as part of the 2017 Tax Cuts and Jobs Act, so if you make a Roth conversion you can no longer reverse your decision.
5. Use a Backdoor Roth IRA. If you exceed the income limits for making Roth IRA contributions you can utilize a technique called a Backdoor Roth IRA to make Roth IRA contributions. Essentially, you turn the Roth IRA contribution into a two-step process. Anyone with earned income can make non-deductible Traditional IRA contributions up to the annual limits ($5,500 or $6,500 age 50+ in 2018). In the first step you make this non-deductible contribution to a Traditional IRA. You now have a full cost basis in the Traditional IRA and can complete a Roth conversion to move the money to your Roth IRA account. Since you had a full cost basis, no tax is owed on the conversion. If you are interested in Backdoor Roth IRA contributions, you must be certain you don’t have any other IRA accounts or you will trip the Pro-Rata rule. If you have any Traditional, SEP, or SIMPLE IRAs, the IRS considers them all to be one big IRA when converting. Therefore, if you have $100,000 in IRAs and try to convert $5,000 of after-tax dollars, only 5% of the conversion will be free of tax and you will owe tax on the other 95%. If you do have other IRAs, you can resolve this issue by transferring your IRA accounts into a 401(k), which won’t trip the pro-rata rule.
6. Use a Mega Backdoor Roth IRA. While this opportunity is only available to a few, high savers can utilize this powerful tool to contribute an additional $36,500 annually to their Roth IRA. First, your workplace retirement plan must allow you to make after-tax contributions. For plans that allow after-tax contributions, once you have utilized your first $18,500 ($24,500 age 50+) of employee deferrals, you want to elect after-tax contributions until you have met your Section 415(c)(1)(A) limit of $55,000 in 2018. This limit includes all employee and employer contributions to your retirement plan, so if you contributed $18,500 and your employer contributed $10,000, you would only be able to make an additional $26,500 in after-tax contributions. Rather than leaving this money in the plan where all the growth will be taxed at ordinary income rates upon withdrawal, you make an in-service transfer to move the after-tax contributions to your Roth IRA where all future growth is tax free!
A husband and wife, both of whom are over 50 and working for employers who allow after-tax contributions could theoretically contribute $135,000 to their Roth IRA accounts. Let’s review how:
They could each contribute $6,500 ($13k total) to their Roth IRA accounts via regular contributions or Back Door Roth contributions (if their income exceeded limits.) They could each contribute an additional $24,500 ($49k total) to their Roth 401(k) and each make $36,500 ($73k total) of after-tax contributions to their 401(k) which they move to their Roth IRAs using the Mega Backdoor Roth IRA strategy. If they still wanted to get more money into their Roth IRAs they could convert an unlimited amount from their tax deferred retirement accounts to Roth with the understanding that every dollar converted will be taxed in the current year at ordinary income rates. That’s how you supercharge your Roth IRA! As always, it is important to talk with your trusted financial professional to make sure these strategies are right for you.