A
move that high earners can make in pursuit of tax-free retirement income.
Does your
high income stop you from contributing to a Roth IRA? It does not necessarily
prohibit you from having one. You may be able to create a backdoor Roth IRA and
give yourself the potential for a tax-free income stream in retirement.
If you think you will be in a high tax
bracket when you retire, a tax-free income stream is just what you want. The
backdoor Roth IRA is a maneuver you can make in pursuit of that goal – a
perfectly legal workaround, its legitimacy further affirmed by language in the
Tax Cuts & Jobs Act of 2017.1
You establish a backdoor Roth IRA in two
steps. The first step: make a non-deductible
contribution to a traditional IRA. (In other words, you contribute after-tax
dollars to it, as you would to a Roth retirement account.)1
The second step: convert that traditional
IRA to a Roth IRA or transfer the traditional IRA balance to a Roth. A
trustee-to-trustee transfer may be the easiest way to do this – the funds
simply move from the financial institution serving as custodian of the
traditional IRA to the one serving as custodian of the Roth IRA. (The
destination Roth IRA can even be a Roth IRA you used to contribute to when your
income was lower.) Subsequently, you report the conversion to the Internal
Revenue Service using Form 8606.1,2
When you have owned your Roth IRA for five
years and are 59½ or older, you can withdraw its earnings, tax free. You may
not be able to make contributions to your Roth IRA because of your income
level, but you will never have to draw the account down because original owners
of Roth IRAs never have to make mandatory withdrawals from their accounts by a
certain age (unlike original owners of traditional IRAs).1,3
You may be wondering: why would any pre-retiree
dismiss this chance to go Roth? It comes down to one word: taxes.
The amount
of the conversion is subject to income tax. If you are funding a brand-new
traditional IRA with several thousand dollars and converting that relatively small
balance to a Roth, the tax hit may be minor, even non-existent (as you will
soon see). If you have a large traditional IRA and convert that account to a
Roth, the increase in your taxable income may send you into a higher tax
bracket in the year of the conversion.2
From a pure tax standpoint, it makes sense
to start small when you create a backdoor IRA and begin the process with a new
traditional IRA funded entirely with non-deductible contributions. If you go
that route, the Roth conversion is tax free, because you have already paid
taxes on the money involved.1
The takeaway in all this? When considering
a backdoor IRA, evaluate the taxes you might pay today versus the tax benefits
you might realize tomorrow.
Three footnotes are worth remembering.
One, a backdoor Roth IRA must be created before you reach age 70½ (the age of
mandatory traditional IRA withdrawals). Two, you cannot make a backdoor IRA
move without earned income because you need to earn income to make a
non-deductible contribution to a traditional IRA. Three, joint filers can each
make non-deductible contributions to a
traditional IRA pursuant to a Roth conversion, even if one spouse does not
work; in that case, the working spouse can cover the non-deductible traditional
IRA contribution for the non-working spouse (who has to be younger than age
70½).1
A backdoor
Roth IRA might be a real plus for your retirement. If it frustrates you that
you cannot contribute to a Roth IRA because of your income, explore this possibility
with insight from your financial or tax professional.
Taylor McClish may be reached at (503) 239-3060 or Taylor.McClish@cunamutual.com
This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.
Securities sold, advisory services offered through CUNA Brokerage Services, Inc. (CBSI), member FINRA/SIPC, a registered broker/dealer and investment advisor. CBSI is under contract with the financial institution to make securities available to members. Not NCUA/NCUSIF/FDIC insured, May Lose Value, No Financial Institution Guarantee. Not a deposit of any financial institution. CUNA Brokerage Services, Inc., is a registered broker/dealer in all fifty states of the United States of America.
Citations.
1 - investors.com/etfs-and-funds/retirement/backdoor-roth-ira-tax-free-retirement-income-legal-loophole/
[4/19/18]
2 - investopedia.com/retirement/too-rich-roth-do/
[1/29/18]
3 - irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions
[11/16/17]
05112018-WR-2489