5 Ways to Get More Money in a Roth IRA
When the world feels like it’s on the brink of implosion, it seems trivial to write or think about taxes. But, with the thought that taxes might go up in the future, especially in Illinois, many are wondering how to get more money in a Roth IRA today (to pay taxes now and not in the future).
Of course, it is not definitive that taxes will increase in the future. In November, Illinois will vote on a “Fair Tax” bill that could increase taxes for some (higher-income earners). On a Federal level, marginal tax rates are scheduled to sunset in 2026 and increase back to where they were prior to the Tax Cuts and Jobs Act of 2017.
Nevertheless, nobody truly knows what taxes will look like in the future. But, for those that are betting on taxes being higher for them, here are 5 ways to get more money in a Roth IRA today.
1. Contribute to a Roth IRA
The easy way to get more money in a Roth IRA is to contribute to one from earned income. If you have enough earned income, an individual can contribute up to $6,000/year ($7,000/year for those 50 and older). For married couples filing jointly, the maximum contribution is $12,000/year ($14,000/year for those 50 or older), even if one spouse has no earned income.
But, there’s a catch. If you make too much money, you aren’t eligible to make a Roth IRA contribution. The income phaseout begins at $124,000 for individuals and $196,000 for married couples filing jointly (all 2020 limits).
2. Back-Door Roth IRA
So, what if you make too much money to contribute to a Roth IRA? Enter the “back-door Roth IRA.” This is when you make a non-deductible (or after-tax) contribution to a Traditional IRA and then immediately convert your contribution to a Roth IRA. This strategy yields essentially the same result as simply contributing to a Roth IRA, but adds one more step. Note: there is still a contribution limit of $6,000/year into a non-deductible IRA, but no income limit applies.
However, beware of the pro-rata rule! When you convert a Traditional IRA to a Roth IRA, you cannot selectively convert only the after-tax amount. The amount of the conversion will be done on a pro-rata basis between pre-tax and after-tax dollars.
3. Convert your Traditional IRA to a Roth IRA
Another option is to simply convert all or a portion of your pre-tax IRA to a Roth IRA. There is no limit on how much you can convert when using this strategy.
However, you must be aware that the amount of your conversion will be fully taxable. The idea here, again, is that you are willing to pay taxes today in hopes of saving more in taxes down the road. To make the best decision, you need to understand how long it takes you to “break even” on taxes paid today vs. taxes saved in the future.
4. Contribute to a Roth 401(k)
It’s possible to avoid the extra hassle of a back-door Roth IRA or a Roth IRA conversion by simply contributing more to a Roth 401(k) now, if your employer’s plan allows. There are no income limits to contribute to a Roth 401(k) and you can also contribute up to the 401(k) deferral limit of $19,500 ($26,000 for those 50 and older).
5. Adjust your allocation in your Roth IRA
One of the main tax concerns for retirees is that they could retire with large pre-tax accounts, causing their taxable income to increase significantly after age 72 (the new age at which you’re required to start taking distributions from your qualified accounts).
In that case, retirees can be forced to take income they don’t need and pay higher taxes if their portfolios are tilted heavily toward pre-tax accounts. One way to minimize this unintended consequence of diligent saving would be to try and decrease the expected return of your pre-tax accounts without decreasing your overall expected return.
This is usually accomplished by making your Roth IRA more aggressive and your Traditional IRA less aggressive, resulting in no change to your overall allocation. Doing this will help minimize future Required Minimum Distributions (RMDs) and, thus, will save you in taxes.
Like anything else, it would be nice to know exactly what the future holds so you could make the best Roth vs. Traditional decision today. But, since that isn’t an option, you could also consider diversifying your account types by using a mix of both. And remember, it’s always best to speak to a licensed professional before making any investment or retirement decisions.
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