By J.P. Dahdah | Vantage IRAs
In 1998, I was a brand-new Financial Advisor starting my career after graduating from The University of Arizona. That same year Congress introduced the Roth IRA to the American people. It has been 25 years since this powerful retirement savings vehicle was created, and yet I do not feel it gets the respect and attention it deserves. According to the Investment Company Institute, Roth IRAs have only been able to attract $1.3 trillion; a mere 21% of all the money currently held in IRA accounts. Considering that withdrawing money from a Roth IRA is completely tax-free and does not disrupt social security benefits or Medicare premiums, you would assume that everyone would be rushing to figure out how they can open, fund, and build their Roth IRA balances. Ironically, it is just not so.
Being bullish on making Roth IRA contributions does require a behavioral trait not commonly found in investors – accepting short-term pain (no current tax deduction) in return for long-term gain (tax-free distributions). People have become so accustomed to getting instant gratification in life, that strategies requiring patience and time to benefit from are rarely preferred. Another hurdle is the income limitations that can make high-income earners ineligible to make Roth IRA contributions.
To qualify in 2022, your modified adjusted gross income cannot be more than $144,000 (filing single) or above $214,000 (married filing jointly). To add insult to injury, the maximum contribution limit for investors under the age of fifty is a mere $6,000 and only slightly more, $7,000, if you are over the age of fifty. The ability to contribute larger amounts into employer-based qualified plans, like a 401(k), is yet another reason why so many Americans opt to participate in those over the Roth IRA. Since most people have not created saving habits early enough in life, they need to “catch up” and often seek out accounts that make it easier to contribute larger amounts. If you are interested in getting the best of both worlds, larger contribution limits, and tax-free growth, it is important to note that according to the Plan Sponsor Council of America, 60% of workplace 401(k) plans allow employees to initiate after-tax or Roth-style salary deferrals (i.e. Roth 401k plans).
3 Conversion Strategies to Supercharge a Roth IRA
I have spent enough time sharing some of the reasons why the Roth IRA has not lived up to its potential. Now it is time to provide a few ways that can help you be purposeful about embracing the power these tax-efficient vehicles offer and load them up with as much of your retirement savings as possible.
- Roth conversion via valuation discounting: One of the biggest windfalls for the Roth IRA occurred in 2010 when the government passed legislation to eliminate the $100,000 income restriction. Even though prudent tax planning is required prior to implementing a Roth conversion, Self-Directed IRA holders are better positioned to take advantage of this advanced tax minimizing strategy. This is because the Fair Market Value (FMV) of alternative assets can be decreased by as much as 40% through IRS-allowed discounting. At Vantage, we call these “Valuation Victories,” and our knowledgeable IRA Specialists are happy to educate you on how this advanced tax minimizing strategy.
- Mega-backdoor Roth conversion via maximum pre-tax contributions: Unlike the conversion mentioned above, this strategy allows employees to possibly convert larger sums into a Roth IRA after contributing the maximum amount to a conventional 401(k). In total, the IRS allows workers to put away up to $61,000 a year in pre-tax, after-tax, and employer contributions – or $67,500 if you are fifty or older. This also includes contributions into a SEP IRA, which along with Solo 401(k) plans, are viable retirement plans to consider for this strategy. Even though the rules vary between 401(k) plans and the SEP IRA, the concept still applies to either type of plan. Essentially, you take advantage of their higher contribution limits, and then turn around and convert the pre-tax account into a Roth IRA.
- Backdoor Roth Conversion via rollover: Keep in mind that a large portion of workplace 401(k) plans allow employees that have reached the age of fifty-nine ½ to roll over their balances into a Traditional IRA, which can then be converted to a Roth IRA. Some plans even allow younger employees that have made after-tax contributions the ability to withdraw solely their after-tax money, pay tax on the earnings, and convert the withdrawal amount into a Roth IRA. This helps younger savers begin to grow their tax-free retirement portfolio much earlier.
In case you haven’t realized, I love the Roth IRA. Implementing the above-referenced strategies has enabled me to grow a healthy six-figure balance in Self-Directed Roth IRA accounts for my family. I strategically direct my Roth IRA funds into real estate and a diverse array of other alternative assets I feel will appreciate greatly. So, when I decide to live off some of my retirement money, I can withdraw my income from various tax-efficient buckets helping me minimize my tax exposure during retirement. If you are not utilizing a Roth IRA in your retirement planning, I hope this article motivates you to take a closer look at how they may benefit you now and in the future.
For more information about Real Estate Roth IRAs, please visit www.VantageIRAs.com.