Funding a Roth IRA – Let’s Count the Ways
Written by Martin Shields
We are strong proponents of Roth IRAs because any growth and income in the account is tax free and unlike traditional IRAs, there are no Required Minimum Distributions (RMDs) for the account owner. Although these accounts have many benefits, it can be difficult to contribute to a Roth IRA because of the income phaseouts. In 2019, the Roth IRA income phaseout for contributions is between $122,000 – $137,000 for an individual filing Single on their taxes and for Married Filing Jointly it is between $193,000 – $203,000. This means that your ability to contribute to a Roth IRA gets phased out from the current annual maximum contribution of $6,000 to $0 at the top of the income phaseout. For individuals who are over the income phaseout, there is the option of doing a back door Roth contribution which is simply making a post-tax contribution to a traditional IRA and converting it to a Roth IRA. This strategy is only effective if an individual does not have an IRA with pretax dollars.
Depending upon your 401(k) plan, there may be the option to contribute to a Roth 401(k). The employee contribution limits for a Roth 401(k) are the same as a traditional 401(k) which is $19,000 for 2019 and $25,000 if you are 50 and older. Most people are not aware that there is an additional option for funding a Roth IRA, which is to make post tax contributions to a 401(k) and convert those dollars into a Roth IRA when you leave the company. This strategy requires you to first maximize your 401(k) employee contribution. Above these employee contribution limits, you then have the possibility of funding your account annually up to a total of $56,000 and $62,000 if you are 50 and older. This additional funding first uses employer Safe Harbor and Profit Sharing contributions. If your plan allows, you may then be able to make post tax contributions to your account up to the limits highlighted earlier. Currently, about 42% of plans allow after tax contributions. It is important to note that these are post tax contributions into your 401(k) account and not contributions into a Roth 401(k).
The graphic below helps illustrate the three main buckets of contributions to a 401(k) plan.
The process to convert these post tax contribution to a Roth IRA occurs when you leave the company. To take advantage of the tax benefits, you will need to make sure that all post tax contributions and growth are rolled into a Roth IRA. This rollover process was validated based on a ruling made by the IRS in 2015.