Maximizing Roth Savings Opportunities

Sarah Brenner reviews strategies for advisers to help clients maximize their Roth savings opportunities.
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By Sarah Brenner

Both Roth IRAs and Roth employer plans have been available for many years, and by now most advisers and their clients, are aware of the substantial value of these accounts. Roth accounts can provide years of tax-free earnings and withdrawals.

While retirement savers may be aware of these benefits, many count themselves out too soon by mistakenly believing they are not eligible to contribute. Others shortchange themselves by not realizing how much more they could be saving. Here is a rundown of strategies for advisers to help clients maximize their Roth savings opportunities.

A good place to start a discussion about Roth savings opportunities is with a client’s employer plan. Clients who have a plan at work should check to see if there is a Roth component. While Roth employer plans got off to a slow start when they first became available, they have now become common. Roth employer plans allow larger contributions than Roth IRAs and, unlike Roth IRAs, they have no income limits.

Contributing to an employer plan with a Roth component is an opportunity for higher income clients to make a Roth contribution of up to $19,500 for 2021.

Those who are age 50 or older can put away even more. They can make an additional $6,500 catch-up contribution for a total of $26,000 in Roth plan contributions for the year. Older individuals are also eligible to make an additional $1,000 contribution to a Roth IRA for a total of $7,000 for the year. Catch-up contributions are often overlooked, resulting in missed Roth savings opportunities for those closest to retirement.

Annual contributions are not the only way to fund a Roth employer plan. Many plans now also allow in-plan conversions from pre-tax accounts to Roth accounts with few restrictions. This can be a good move for a client who has funds in an employer plan but is not currently eligible to take a distribution from the plan in order to do a Roth IRA conversion. An in-plan conversion allows the client to fund a Roth account within the plan. Keep in mind that an in-plan conversion, like any Roth conversion, is a taxable event and cannot be undone.

A common question that comes up is whether it is possible to fund a Roth employer plan and also a Roth IRA in the same year. The answer is yes. An individual who is eligible and has the funds available could potentially do both. Many do not realize this and, therefore, miss out on maximizing their Roth savings. A client who can do both could potentially contribute up to a combined $33,000 for 2021 by contributing $26,000 to a Roth employer plan and $7,000 to a Roth IRA.

When it comes to Roth IRA contributions, a barrier for higher-income clients is that the ability to contribute phases out at higher income levels. A workaround to suggest to higher-income clients is the back-door Roth IRA. A client with earned income can make a nondeductible Traditional IRA contribution and then convert that contribution to a Roth IRA. There are no income limits for making nondeductible Traditional IRA contributions and no income limits on Roth IRA conversions. This allows funding a Roth IRA indirectly despite the income limits that prevent making Roth IRA contributions directly.

Some advisers in the past have been hesitant to recommend the back-door Roth IRA strategy. This concern appears to be unfounded as Congressional reports accompanying recent legislation and comments from IRS officials show acceptance of the strategy.

Be sure that clients who use the backdoor strategy understand how it works. An area that sometimes causes confusion is the pro-rata formula that applies to all Traditional IRA distributions, including those that are converted. If the individual has other existing pre-tax IRA funds, those funds will be included in determining the taxes on the conversion of a nondeductible contribution when using the back-door Roth IRA strategy. This can result in a tax bill. advisers should be sure that clients are prepared for this, so it does not come as a surprise at tax time.

More older clients can now take advantage of the back-door Roth IRA strategy than ever before. This is thanks to a law change that was part of the SECURE Act, which became effective for 2020. Prior to the SECURE Act, those over age 70½ could not make Traditional IRA contributions. That prevented older individuals with earned income from taking advantage of the back-door Roth strategy. Now older clients no longer face that barrier. advisers should reach out to older clients to let them know they too can now do a back-door Roth IRA.

Clients who are stay-at-home parents or caretakers for aging parents face special challenges when it comes to retirement savings. The good news is that these individuals are not necessarily shut out from Roth IRA contributions. If they are married, they may consider making a spousal Roth IRA contribution using their spouse’s earned income. Those clients whose income is too high might consider a “spousal” back-door Roth IRA. They could simply make a spousal nondeductible traditional IRA contribution and then convert those funds to a Roth IRA.

For clients with no earned income available, advisers can look beyond tax-year contributions to conversions. There is no requirement that an individual have earned income to convert an existing Traditional IRA (or a SEP or SIMPLE IRA) to a Roth IRA. There are no income limits and no age limits. The bottom line is that anyone with one of these retirement accounts can fund a Roth IRA by doing a conversion. Clients who are hesitant about the tax hit can use strategies like partial conversions over several years to minimize the impact.

If a client is eligible and willing, both contributions and conversions can be done. There is nothing in the rules that prevents a client from doing both for the same year. Making this strategy even more attractive for those doing larger conversions is the fact that income from the conversion is not included when determining eligibility to contribute under the Roth IRA contribution income limits.

Every client’s situation is a little different. When it comes to maximizing Roth savings opportunities, the key is to explore all the possibilities. While not every client can take advantage of all strategies, with proactive planning many interested clients can find a way to fund a Roth account and some can substantially increase their savings.

About the author: Sarah Brenner, JD, is director of retirement education for Ed Slott and Co. She has worked for almost 20 years helping clients solve complex technical IRA questions. She is a contributing writer and editor for Ed Slott’s IRA Advisor newsletter, distributed to thousands of financial advisers nationwide, and writes for several areas of the company’s website, IRAHelp.com.

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