By Michael McKeown, CFA, CPA – Chief Investment Officer
Outside of saving in your employer’s retirement plan, there are two types of Individual Retirement Accounts (or IRAs) – Traditional and Roth. In a traditional IRA, your contributions are tax-deductible now but are taxed on withdrawals in retirement. In a Roth IRA, your contributions are taxed now but your withdrawals are tax-free.
Depending on your current tax rates and where your rates will be in retirement, it can make sense to build up the balance in one type of account over the other.
Roth IRAs provide more flexibility in retirement since distributions come out tax-free. In addition, Roth IRAs do not have required minimum distributions like traditional IRAs.
Here are three ways to increase your Roth IRA:
1. Contribute to a Roth IRA. The contribution limit is $6,000 in 2019 with an additional $1,000 catch-up contribution for those over 50. The income limit for the full contribution is $122,000 for single filers and $193,000 for married filers. The maximum contribution amount begins to phase out after these levels.
2. A Backdoor Roth contribution. If you do not have a balance in any traditional IRAs, you can contribute to the traditional IRA and shortly after moving those funds to a Roth IRA. This gets around the income limits from the first option. The key is to move your IRAs into your employer’s retirement plan by the end of the year (12/31), so you do not have a balance on IRAs.
3. Roth Conversion. This can make sense if you have a traditional IRA and happen to be in a lower income year than you expect to be in the next few years or in retirement. You can convert your assets from your traditional IRA to Roth IRA assets by recognizing the income today. There is not a limit on conversion, it only depends on how much income you want to recognize without bumping up into a higher tax bracket. Income limits do not apply either. When you take distributions in retirement, they will be tax-free.
Having both traditional IRA and Roth IRA assets is smart for more flexible spending and tax options during retirement.
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