Tax and Retirement Strategy for High Earners in 2018

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Tax and Retirement Strategy for High Earners in 2018

If you want a more secure financial future and retirement, it may be time to consider using a Roth IRA.

As an introduction, Roth IRAs allow you to save for retirement and receive tax-free investment returns, while retaining access to your funds if and when you need them.

Why are Roth IRAs Underutilized?

Everyone’s hot on Roth IRAs, but there’s one drawback: There are income limits starting at $189,000 for a couple and $120,000 for an individual.  Instead, most people tend to rely on a traditional IRA or 401(k) account. They may not realize that a Roth IRA can offer tax benefits, access to funds, ease of use, and retirement income benefits that are too attractive to ignore.

The ‘Backdoor’ Roth IRA

A strategy called the ‘backdoor’ Roth IRA makes it possible for high earners to bypass the income limits. It involves a two-step process that effectively enables certain high-income taxpayers to skirt the Roth IRA contribution income limits, viewing it as a smart technique to make the most of questionable rules.  However, some critics argue that it should be avoided out of concern that the IRS could disallow the move thanks to something known as “the step-transaction doctrine.”

The Step-Transaction Doctrine Concern

The step-transaction doctrine holds that a court can invalidate a transaction if the separate steps involved in the transaction have no independent substantial business purpose. In the context of the ‘backdoor’ Roth IRA strategy, the thinking goes that if the separate steps of the non-deductible IRA contribution and subsequent Roth conversion are done too quickly, (or simultaneously) there is some risk the IRS could attempt to invoke the step-transaction doctrine in order to invalidate the Roth conversion.

How Does the Backdoor Roth Work?

You can do a backdoor Roth IRA in one of two ways. The first method is to contribute money to an existing Traditional IRA, sell shares, and then roll over the money to a Roth IRA account. Or, you can convert an entire Traditional IRA account to a Roth IRA account. (The experts at CKS Summit Group will be able to help you with the mechanics.) Your Traditional IRA doesn’t have to be new. You can roll over existing Traditional IRA money—or an old Traditional IRA account—into a Roth.

Below are some tips to consider before doing a ‘backdoor’ Roth IRA:

  • Understand the Roth IRA contribution income limits for the taxable year in question
  • Determine whether you have any existing pre-tax IRA funds. If so, understanding the IRA attribution rules under Internal Revenue Code Section 408(d) is crucial
  • Are you currently participating in an employer retirement plan? If so, rolling over existing pre-tax IRA funds to an employer plan may help you circumvent the IRA attribution rules.
  • Be mindful of the step-transaction doctrine and consider waiting at least several months between the non-deductible contribution and the Roth IRA conversion

Article Summary

  • A backdoor Roth IRA allows you to get around income limits by converting a Traditional IRA into a Roth IRA.
  • Contributing directly to a Roth IRA is restricted if your income is beyond certain limits, but there are no income limits for conversions.
  • The amount of money you can contribute to a Roth IRA is normally limited, but a backdoor Roth IRA has no limits on the amount of the conversion.

Final Thoughts

Don’t think it is too late to start using this valuable savings vehicle. The ‘backdoor’ Roth remains a subject of debate over the long term so if you want to take advantage of this strategy, you may want to do so before policy changes.

If it all feels a bit overwhelming, speak to the retirement income advisors here at CKS Summit Group who can help you set up a plan and invest for your future with a Roth IRA. Click here to get in touch today, or call us at 586-286-5820.