Roth IRA:Put plan to retire on steroids
Raj and Monica, 30 year-old successful software engineers with a multinational search engine/cloud computing company in Mountain View, recently filed their 2012 Federal and State taxes. They sensed a dilemma and contacted our office through our website (i.e. they “Googled” us). Being good engineers they like not only to “plan” but also “stress test” and “optimize” their plans. Raj and Monica do not want to be like other retired Americans who see Social Security as their primary source of retirement income. They, like many, are leery of the future of Social Security and want to take advantage of every, appropriate-for-them, tax-saving idea our government allows for preparing for and protecting their own retirements.
Their dilemma is that they participate in their company’s 401k and earn too much combined income to qualify for traditional tax-deferred individual retirement assessment deductions (maximum adjusted gross income for couples in ’13 is $115,000, for singles is $69,000). So traditional deductible IRA contributions are out. They also earn too much combined income to qualify for traditional tax-free accruing Roth IRAs (maximum adjusted gross income for couples in ’13 is $188,000, for singles is $127,000). So, traditional Roth IRA contributions are out. Raj and Monica wish to maximize their retirement contributions beyond their company 401k contributions, maximize future tax savings and take advantage of little known IRS laws applicable to their situation … so what can they do?
We suggested the Backdoor Roth IRAs (traditional contribution + traditional IRA-to-roth IRA conversion = [Backdoor] Roth IRA) for both Raj and Monica. We showed Raj and Monica how the simple 4-step process works: 1) Each person contributes up to $5,500 ($6,500 for those over age 50) per year to a traditional IRA (non-deductible), 2) Immediately convert your traditional IRA to a Roth IRA, 3) Pay any taxes on the gains before conversion (since it was “immediate,” is probably close to zero) and 4) The full contribution for Raj and Monica of $11,000 per year, using after-tax dollars will grow tax-free (not just tax-deferred as in the traditional IRA) and is available without penalty (just like a traditional IRA) anytime after age 59 1/2, as long as the account has been in place for at least five years.
Note that one very important aspect as their advisor, we check, prior to deploying this tax planning technique whether a client has any other deductible IRA accounts. This technique works best for those who do not have other deductible IRA accounts (i.e., IRA accounts with pre-tax contributed money) at the time of converting your non-deductible IRA to a Roth IRA. If you have other deductible IRA accounts at the time of conversion, a portion of that conversion will be taxable.
How does this work out? Predictably, when we performed a retirement calculation for Raj and Monica, we found that even the combination of their 401k contributions and anticipated Social Security would not meet their retirement income goals. But by adding annual Backdoor Roth IRA contributions of $5,500 each per year until age 50, and $6,500 each per year after age 50 until their stated retirement at full Social Security payout age of 66, we were able to project an additional $1,169,590 (example anticipates 5 percent growth per year) in tax-free retirement savings. Raj and Monica posted our website on their Facebook so their friends could get more information about this retirement planning “optimizer.”
The opinions voiced in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual. Consult your tax professional before taking any specific action or engaging in any specific strategy. NPC does not render tax advice.
Allen Ostrofe, MBA CFP is president of Ostrofe Financial Consultants Inc., an S.E.C. fee-based registered investment advisor. Securities and advisory services offered through National Planning Corporation, member FINRA/SIPC, a registered investment advisor. Ostrofe Financial and NPC are separate and unrelated companies. For questions or suggestions, visit http://ostrofefinancial.com. Branch address: 565 Brunswick Road, Suite 15, Grass Valley.
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