Roth IRAs Have Become an Even Better Option for Retirement Savings
The Roth IRA is usually touted as a bargain for young workers: you pay taxes on the money that comes in now, and then when you get older (and in theory in a higher income group) and withdraw funds, you don’t have to worry about it. With traditional IRAs, the money you invest is tax-free, and when you withdraw it, it is taxed as regular income. But now Roths may be even more attractive to wealthier workers.
That’s because the new tax bill lowers tax rates for those in the top group from 39.6 percent to 37 percent. This is the lowest percentage you are likely to receive, which makes the conversion especially attractive before bids rise. Basically, you are guaranteeing yourself a low tax rate on your retirement savings now, rather than potentially paying more in the future.
Of course, tax rates can be even lower, although they have been much higher for most of our history. In all likelihood, they are likely to start coming back from here in future administrations (especially given the deficits that this plan only exacerbates).
How to make a switch
To deposit new money in Roth, you need a modified gross income of less than $ 135,000 as an individual, or less than $ 199,000 if you are applying with your spouse. But if you already have a traditional IRA, you can open Roth and transfer money to it from your other account regardless of your income (known as the Roth IRA backdoor). You pay income tax on the entire convertible amount of money, but then it rises without taxes.
While Roths generally have $ 5,500 ($ 6,500 if you’re 50 or older) contributions per year, just like a traditional IRA, there is no contribution cap with a Roth backdoor IRA.
But there is something to keep in mind if you are considering converting. First, we are talking about very rich people.
“I usually only recommend it to clients who have enough non-IRA funds to pay the taxes due at their maximum marginal rate,” says Lawrence Soras, co-founder of Mulberry Lane Advisors, LLC in New Jersey. clients will not be penalized for early withdrawals. If you don’t have enough other funds to pay the tax right now, don’t do it. You can use this calculator to figure out what kind of down payment you need.
This is especially important because the tax plan also ruled out your ability to reverse the Roth conversion (known as re-qualification ) – which means there is no turning back if you find your tax burden is too high. And if you are converting a large amount of money, it can push you towards a higher tax tier in general (especially if you are on the verge of a certain tax tier ).
It also depends on the amount of time before using the funds. “The longer the time horizon, the more benefit you will get from the transformation,” says Soras. Therefore, if you are approaching retirement age and soon want to get funds and think that a market downturn is inevitable, you may want to think twice about this strategy, because in the end you may get less than you invested.
However, if you have enough money, this can be a smart move to reduce your tax burden. And young workers may want to open one if they’ve run out of their 401 (k) contributions and want to save more money for retirement, or if they don’t have a 401 (k) option.