Roth Revolution: Transforming Your Retirement Strategy

It’s April 2024, and it’s that time of the year again—tax season. While it might not evoke the same excitement as the holiday season, it's a crucial period for financial planning. By now, you're likely finalizing your tax returns or considering an extension.

During this time, we often receive questions about contributing to an IRA for the previous tax year. You might be surprised to learn that you can still contribute to your IRA until your tax filing deadline, which, for most of us, is April 15th.

Among these conversations about IRAs, the topic of Roth versus Traditional often arises. So, let’s delve into Roth and discuss some planning tips around it.

What is a Roth and why?

First, the basics. What is a Roth? A Roth typically refers to a Roth IRA (Individual Retirement Account) or a Roth 401(k), both of which are types of retirement savings accounts.

A Roth IRA is an individual retirement account that allows individuals to save for retirement with after- tax dollars. Contributions to a Roth IRA are not tax-deductible, but qualified withdrawals, including earnings, are tax-free in retirement—yes, tax-free! However, it's essential to meet all qualification rules to enjoy these benefits.

A Roth 401(k) is a variation of a traditional 401(k) retirement savings plan offered by employers. Contributions to a Roth 401(k) are made with after-tax dollars, and similarly, withdrawals can be tax-free in retirement if certain conditions are met. However, unlike a Roth IRA, there are no income restrictions on who can contribute to a Roth 401(k).

Who can contribute to a Roth IRA?

For a Roth IRA, your ability to contribute is based on your modified adjusted gross income (MAGI). As of 2023, the phase-out range for single filers begins at a MAGI of $138,000, increasing to $146,000 in 2024. For married couples filing jointly, the phase-out range begins at $218,000 in 2023 and increases to

$230,000 in 2024.

There are no age limitations for contributing to a Roth IRA, if you have earned income (e.g., wages, salaries, self-employment income).

Spousal IRA

Even if one spouse does not have earned income, they can contribute to a Roth IRA based on the other spouse's income, subject to certain limits.

Strategies for high income earners

High-income earners who are not eligible to contribute directly to a Roth IRA, due to income limits, may still access a Roth through various strategies.

Roth Conversions

One way to access the benefits of a Roth is through a Roth Conversion. This involves moving funds from a traditional IRA, 401(k), or other qualified retirement account into a Roth IRA. While you'll owe income taxes on the amount converted in the year of the conversion, once the funds are in the Roth IRA, they can grow tax-free, and qualified distributions in retirement can be tax-free.

Backdoor Roth IRA

Another popular strategy for high-income earners is the "backdoor Roth IRA." This involves contributing to a Traditional IRA, making nondeductible contributions, and then converting the funds to a Roth IRA.

Since there are no income limits for Roth IRA conversions, even high-income earners can benefit from this strategy.

However, it's essential to consider the tax implications. If you have other traditional IRAs with pre-tax contributions, the IRS applies the pro-rata rule to the conversion. This means you can't just selectively convert only nondeductible contributions to a Roth IRA without also converting a proportional amount of pre-tax contributions.

So, if you have large balances in a traditional IRA, this strategy may carry a heavy tax bill. You may be able to sidestep this issue by transferring that large pretax IRA balance to an employer sponsored qualified retirement plan (like your 401k). This shift may allow you to avoid the pro-rata rule.

Mega-backdoor Roth IRA

The mega-backdoor Roth IRA strategy involves maxing out normal 401(k) contributions, contributing after-tax dollars up to the overall limit, and then making an irrevocable transfer of the after-tax funds into a Roth IRA. This strategy can be complex and requires verification of procedures allowed by your employer's retirement plan.

Summary

Roth conversions, backdoor Roth, and especially the mega-backdoor Roth, can be complex. Therefore, I recommend seeking the assistance of your tax professional or financial planner to ensure these

strategies align with your overall financial plan and tax situation. Additionally, stay informed about any updates in tax laws and regulations that may affect these strategies.

Bonus insights…

Starting in 2024, the SECURE Act 2.0 allows owners of 529 college savings plans to convert unused funds to the beneficiary’s Roth IRA. This new law offers significant benefits, especially for those with large 529 account balances whose children have completed college and have unused funds.

Conclusion

“It is said that our taxation system is a voluntary one. Do you remember when you volunteered?” – Unknown.

While volunteering for the tax system may not be on anyone's wish list, optimizing your assets to pay fewer taxes during your lifetime certainly is. If you're considering how Roth options might benefit you, don't hesitate to reach out to us for assistance.

Until next time,

Jason D. Newton, CFP® Financial Advisor
Vice President – Investments
Crescent Advisory Partners of Raymond James

www.crescentadvisorypartners.com jason.newton@raymondjames.com 843.942.7203

*Any opinions are those of Jason Newton and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Prior to making an investment decision, please consult with your financial advisor about your individual situation.

Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.

Roth IRA - Earnings withdrawn prior to 59 1/2 would be subject to income taxes. Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Like Traditional IRAs, contribution limits apply to Roth IRAs. In addition, with a Roth IRA, your allowable contribution may be reduced or eliminated if your annual income exceeds certain limits.

Contributions to a Roth IRA are never tax deductible, but if certain conditions are met, distributions will be completely income tax free. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.