The Roth IRA offers substantial retirement planning benefits as it is a great, tax-efficient way to save for retirement. Money saved in a Roth IRA grows and distributes tax free. This can be extremely powerful in retirement, particularly for individuals that potentially have decades of tax free, compounded growth to benefit from before they need to access their Roth IRA in retirement.
The problem that you might face when trying to max out your Roth IRA contributions is simply that there are some income restrictions in place; however, there are a handful of ways in which you can indirectly fund your Roth IRA. Here are three that are worth considering.
The Mega Backdoor Roth IRA
The first option is to make the maximum allowable contribution to your 401(k). You may even wish to contribute some after-tax dollars, if your employer allows you to do so.
There are a couple of reasons why you might contribute after-tax dollars to the 401(k). Within the 401(k), your earnings will grow tax deferred. As such, more of your investment is re-invested, allowing your money to grow as much as possible.
But the main reason to contribute after-tax dollars to your 401(k) is that these contributions can be rolled into your Roth IRA once you retire or leave the company. So, if you’re currently unable to make Roth IRA contributions because of those income restrictions, this can be a huge work-around. (That’s why this is called the “mega backdoor” for funding a Roth account.) There are no limitations on after-tax dollars you contribute to your 401(k), so you can make those contributions and then simply move them into the Roth account when you leave the company.
The Backdoor Roth IRA
Another option is to do the same thing we outlined above, but on a slightly smaller scale, specifically with a non-deductible IRA. Again, this is a good workaround for those restricted from contributing directly to their Roth account. Simply max out your non-deductible IRA, then immediately convert it into your Roth IRA.
(Note that this works best if you don’t have any traditional IRAs in place; if you do, you’ll run into some pro-rata rules that complicate things a little.)
Convert Your Traditional IRA to a Roth IRA
Those who do have a traditional IRA may wish to consider converting it into a Roth account… assuming it makes sense to do so. This is the right move for some but not for all, and it’s important to talk it over with your financial planner and tax advisor before you come to a final decision.
Converting from a traditional to a Roth IRA can make sense depending on your tax situation and your time horizon until you plan to access the funds. The lower rates from the 2017 tax law overhaul have placed many earners into lower tax brackets than ever before, and these rates are set to expire in 2025. Thus, anyone who is going to convert from a traditional to a Roth IRA would probably want to do so sooner rather than later, certainly before 2025.
Questions About Maxing Out Your Roth IRA?
As you can tell, you’ve got a few options for maximizing contributions to your Roth IRA. To speak with a financial planner about which approach is right for you, we encourage you to contact Stonepath Wealth Management at your next convenience.