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We have been talking with many clients about the benefits of additional Roth dollars in their portfolios. Roth money has already been taxed, grows tax-free, and can be distributed 100% tax-free in retirement. Tax-free withdrawal provides the ultimate flexibility in retirement. Having a portion of the portfolio tax-free allows us as Investment Managers to minimize taxes in retirement, ultimately increasing the probability of a successful retirement.
Roth IRAs are a common Individual Retirement Account that anyone can establish and fund. Many times, we hear from clients that they can’t contribute because they are over the income limits. Yes, this may be true, but we can still fund the Roth IRA using a backdoor Roth IRA strategy. This is where we fund a Traditional IRA and then convert those funds into a Roth IRA. If there is a balance in the IRA before the funding, there will be a tax that needs to be considered upon the conversion.
Another way to fund Roth is through a 401(k) Plan. Roth options are available in most 401(k) plans today. Roth 401(k) allows one to contribute additional dollars into a tax-free environment. The maximum Roth 401(k) contribution in 2024 is $23,000 with an additional $7,500 catch-up for individuals over age 50. This is a significant contribution to an account that will grow tax-free forever. The tradeoff is that the contributions aren’t tax deductions like a traditional 401(k), so it’s going to feel like the contributions are the full amount, whereas the 401(k) contributions feel like the pretax amount.
Another less-known strategy is called the Mega-Backdoor Roth IRA. Many 401(k) plans don’t allow this but if they do, it should certainly be considered. If a 401(k) allows for After-Tax contributions and the plan allows for in-plan conversions this can be an incredible strategy. The total IRS contribution limit into a 401(k) plan for 2024 is $69,000 (plus $7,500 for people aged 50 and over). This includes employee and employer contributions. This allows significant after-tax contributions. Like the Backdoor Roth IRA, when after-tax contributions are made, no tax deduction is taken and those dollars can be then converted into the Roth portion of the plan, without paying any tax. If there is any growth in the after-tax account, that will be a taxable conversion, so it usually makes sense to convert shortly after contributing, if possible.
Roth Conversions are also a possibility. If there is a balance in an IRA, there’s always an option to convert these funds into a Roth IRA. The converted amount will be considered ordinary income for tax purposes so it’s important to work closely with a CPA to determine the right amount of the conversion, if any. With possible tax increases on the horizon, this can be a great way to protect savings from future tax increases. One technique we use often is to work with a CPA and to determine the maximum amount of conversion until we reach the next tax bracket for a client. This can be useful to be sure we take advantage of the lower tax brackets to their limits.
At OmniStar, we are constantly looking for different strategies to increase successful outcomes for our clients. Roth options are wonderful tools that we look at often and we’ll likely talk about them in future reviews. Please reach out to your team if you have any questions or if you’d like to discuss this further.
