A Roth 401(k), Roth IRA, or Roth IRA are the best ways to save tax-free money for retirement. Roth accounts allow you to save tax on your money. All income, including investment gains, is exempt from tax when it is withdrawn at retirement.
However, it is important to comply with the rules that govern Roths. The maximum amount you can contribute to a Roth IRA per year is $6,000 for individuals under 50, and $7,000 for those over 50. Roth contributions are not available to those who have higher incomes (e.g. single tax filers ($137,000, married filing jointly $203,000) — the ones who will benefit most from a Roth IRA.
You have options if you wish to make more contributions than allowed and increase your Roth retirement savings by thousands of dollars.
The “back-door Roth IRA” strategy is one way to circumvent the contribution limit. This involves making aftertax contributions into your employer’s 401k plan, and then transferring these contributions to a Roth IRA. You can do this even if your income is below the limit.
The catch is that you must be a participant in a 401(k), which allows aftertax contribution and allows for an “in-service withdrawal”.
Here’s how a back-door Roth works. First, you need to “top up” your 401(k), by making aftertax contributions. 2019’s 401(k), contributions limit is $19,000 or $25,000 for workers 50 years and older. Employer match up to $6,000. Many 401(k), which allow aftertax contributions, have a maximum IRS limit of $56,000 for workers 50 years and older. If you make $19,000 in 2019, and your employer matches you with $6,000, then you can make an additional aftertax contribution of $31,000 ($56,000 less $19,000 and $6,000 respectively) or $37,000 for workers 50 years and older.
Next, you will need to take an “in service withdrawal” of any additional aftertax contributions immediately and then transfer it to a Roth IRA. It is best to do this right after the additional aftertax contributions have been made. This will ensure that there are no earnings accrued. You will also need to withdraw any earnings that have been credited to aftertax money.
The withdrawn earnings are taxable but you can roll them over to a traditional IRA. The earnings will not be added to your taxable income unless they are withdrawn from the traditional IRA later. Before you open a Roth IRA, make sure that you have it activated. Once you have done this, the money after taxes will be available to deposit into the new account once it is distributed.
A 401(k), plan that offers a unique feature, is another way to increase the amount of money you can save in Roth accounts. Employers may allow Roth 401k in-plan conversions within their retirement plan. Participants can make aftertax contributions as long as the plan allows. Participant can choose to convert their contributions into Roth-type contributions instead of taking an “in service withdrawal”.
This feature is being offered by some plans, including Google’s at the end of each year. This will allow employees to start 2019 with this important feature.
Roth savings work best when used as part of an investment strategy. The more money you invest in Roths, the greater the investment returns. These gains can be tax-free when the money is withdrawn in years later.
Before you move forward, ensure that the Roth accounts you have saved are not used for anything other than retirement. Roth accounts funds must be withdrawn after 59 1/2 years of age and must have been invested for at least five consecutive years.
Roth accounts don’t have to be distributed at the minimum required rate for those who are over 70 and have other IRAs or retirement accounts.
Before you start a Roth-maximizing strategy make sure it is reviewed by your tax and financial advisors.
