Last Week’s Question of the Week: How much per taxpayer, per year can you transfer to a charity using the Qualified Charitable Distribution Rule? Is it $10,000 per year, or $100,000 per year?
ANSWER: $100,000 per year.
HOST: Today your retirement planning topic revolves around Roth IRAs, Roth 401ks and also “backdoor conversions?”
KLAAS FINANCIAL: Yes, this is an exciting topic to discuss today! As many people know you may have several options of storing away your retirement monies into retirement accounts like 401ks, 403bs, and IRAs. It of course depends on where you work and what options are offered.
Traditionally, most people have added monies from their paychecks or savings to either traditional retirement plans as pre-tax contributions, or contributed into their IRAs offering a deduction to their taxable income, so that when they do retire someday, those monies will have grown tax-deferred and then as they take a distribution out the money will then be taxed according to their tax rate at that time.
Back in 1997, Roth IRAs were introduced and became a way for people to begin saving retirement dollars with after-tax dollars. Since the contributions to Roth IRAs are non-tax-deductible at the front end, once you start withdrawing funds in retirement the money comes out (generally) tax free.
What to know about Roth IRAs:
- There is no up-front tax deduction for Roth IRA contributions as there is with a traditional IRA since you are funding it with post-tax income. So again, remember you do pay taxes now.
- They have the same contribution limits as traditional IRAs. In 2020, the total amount you can put into all IRAs, traditional or Roth is $6000 if you are under 50 years old; $7000 if you are over 50 which includes the catch-up contribution of $1000.
- Just like with traditional IRAs you have to have earned income to make contributions. If you earn less than the maximum contribution limit, you can only contribute as much as you have earned for the year within the contribution limits. Non-working spouses can contribute the maximum amount to a Roth IRA as long as the working spouse earns enough to cover the contributions to both accounts and the household income doesn’t exceed the IRS income-eligibility limits.
This now brings us to IRS income-eligibility limits. Who can and cannot add money to ROTH IRAs?
- The income limits for 2020 Roth IRA contributions depend on your tax filing status and how much your modified adjusted gross income is. If you are single, or head of household, your contributions are allowed with income under $124k, and phased out between $124k-$139k. Married filing jointly, contributions are allowed with income under $193k, and phased out between $193k-$203k.
- Roth distributions are tax-free when you follow the rules. You can tap your contributions (but not your earnings on those contributions) at any time, tax-free and penalty-free.
- You can contribute to a Roth IRA until you file your taxes towards the previous year’s limit.
- Benefits: The benefit of a Roth IRA all depends on the beholder’s tax bracket, both now and when he or she retires. Roth IRAs make the most sense if you expect your tax rate to be higher during retirement than your current rate. Generally, Roth IRAs are ideal savings vehicles for young, lower-income workers who will not miss the upfront tax deduction and will benefit from decades of tax-free, compounded growth.
HOST: So, what if we have access to a Roth 401k? Should we consider contributing to one?
KLAAS FINANCIAL: Possibly. Roth 401ks are an employer-sponsored investment savings account that gives employees the opportunity to save for retirement with after tax money. These were first offered as an option to retirement plans back in 2006. Still today, a Roth 401k option is not in every retirement plan out there. However, according to Fidelity Investments they indicate they are becoming more widely available with 70% of company plans now offering a Roth option, up from 59% just three years ago. So the answer to whether should you contribute to one is always, it depends. But here are some facts:
What to know about Roth 401ks:
- There are no income limits when contributing to a Roth 401k, whereas we do have those with the Roth IRA contributions.
- The maximum amount that you can contribute in 2020, between a traditional 401k and Roth 401k is $19,500 or $26,000 if you are over 50. Some people will put 100% in one plan, or maybe 50% into one plan and 50% into the other, again depending on taxation and perhaps age considerations.
- When you retire you will likely roll the Roth 401k into a Roth IRA. If you don’t, an existing Roth 401k will require RMDs at age 72.
HOST: What about Roth Conversions? Or a backdoor Roth?
KLAAS FINANCIAL: A conversion means that you are actually choosing to pay taxes due today (according to your current tax bracket) on the IRA, and then placing it into a Roth IRA, where taxes will never be owed again. Sometimes this is referred to a “backdoor Roth”.
Why is it called a backdoor? Simply because maybe your income was too high to qualify to add money to a Roth IRA on the way in; but at any time you can convert money from the traditional IRA to a Roth IRA, with no restrictions to income.
Keep in mind; this is not a tax dodge. You will need to pay taxes on any money in your Traditional IRA that has not already been taxed. The funds that you convert to a Roth IRA will most likely count as income, which could kick you into a higher tax bracket in the year you do the conversion.
On the other hand, if your income happens to be unusually low in a particular year (perhaps you had a gap in employment) you could take advantage of that situation by making the Roth conversion then. Timing is important. Calculate the tax implications of a Roth IRA conversion before you decide. Speak with your accountant. There is no age limit for doing a Roth conversion. So yes, you could complete one at age 70 or 75. You could do one at age 90 if you like.
Converting to a Roth IRA may make sense if:
a) You will likely be in a higher tax bracket in the future.
b) You don’t want to begin taking RMD distributions at age 72.
c) You are moving to a state with higher state income taxes.
d) You want to leave a tax-free inheritance to your heirs.
In summary, please speak to your accountant and financial advisor and see if this may make sense for your own situation.
HOST: Amy from our Money in Motion Listener Corner asks: “I received a stimulus payment for $1200 from the government. I want to know if this money will be added to my taxable income in 2020?”
KLAAS FINANCIAL: Great question Amy, thanks for writing in. Our understanding per the CARES ACT, is that the stimulus checks will not be added to your income this year, and essentially are a gift to you. For individuals earning up to $75,000, and couples earning up to $150,000; this income has been structured as refundable tax credits.
This Week’s Question of the Week: What is the maximum amount a 55-year-old can contribute into a ROTH 401k in 2020? Is it $19,500? Or is it $26,000?
Catch C.J. Klaas and Maleeah Cuevas on Money in Motion every Thursday on Madison's 1310 WIBA from 8:05-8:35am.