Saving into a Roth IRA

As we have said in previous blogs, it is important for individuals to attempt to save money into three distinct “buckets” during their working years.  These buckets are the pre-tax bucket, the after-tax bucket and the Roth bucket.  This blog will focus on saving into the Roth bucket.  Roth savings accounts grow tax-deferred and qualified distributions come out tax-free so this is an important bucket when it comes to your savings strategy.

How does one save into the Roth bucket?  The easiest approach is to contribute directly into a Roth IRA.  In order to contribute into a Roth IRA, you must have earned income.  The maximum amount an individual can save for 2019 is the lesser of $6000 or total compensation.  Wage earners who are 50 years of age or older can also save an additional $1000.  Not everyone is permitted to contribute to a  Roth as there are income thresholds that Congress

has set after which a person earning more than these income limits cannot contribute to a Roth IRA.  These thresholds are as follows:

What if your employer does not offer a Roth option with your 401(k) plan and you make more than the income limits shown above?  How can you contribute to this important savings bucket?   The good news is that there is a third option which is often referred to as a back door Roth IRA.  This approach works as follows – make an initial contribution to a non-deductible IRA in your name.  The dollars used to make this contribution are after-tax dollars and you will not be able to take an income tax deduction for the contribution on your tax return.  After a period of time, somewhere between 2 to 4 weeks, you can then transfer those funds from the non-deductible IRA to a Roth IRA. (See the illustration below.)
Another approach is to make Roth contributions to your employer’s 401(k) plan.  Not all employers provide a Roth option with their retirement plan so you should check with your employer’s HR department to see if such an option is available.  A key point as it relates to 401(k) plans with a Roth option is there are no income thresholds applicable to retirement plans.  So, regardless of how much money you make, you can make Roth contributions to your 401(k) plan if your plan offers a Roth option.  The Roth 401(k) option allows a higher level of contributions – $19,000 for individuals under the age of 50 and $25,000 for individuals aged 50 and older.If your income is within the ranges shown above, you can make a partial contribution.  Using a simple example, if you are married filing a joint return and made $198,000 (halfway between the range shown above) you can only make a $3000 contribution (50% x $6000).

There are two keys to being able to effectively complete this strategy:

1. You do not have another traditional IRA in your name besides the non-deductible IRA you set up to utilize this strategy.
2. You do not invest the funds initially deposited into the non-deductible IRA so that there are no taxes due when you make the transfer to the Roth IRA.

In summary, it is important for everyone to contribute as many dollars as possible to the three buckets mentioned above during their working years.  Often, the bucket that gets forgotten is the Roth bucket, especially if your employer does not have a Roth option with the company retirement plan.  So, do yourself a favor and select the option above that best fits your financial situation when it comes to saving into a Roth account.  You will be far better prepared for the financial distribution phase of your life if you do.