For investors whose income exceeds the Roth IRA eligibility threshold there are a few popular strategies to get money into these accounts that grow tax-free (as opposed to tax-deferred). Unfortunately, the time may be drawing nigh to continue those strategies.
First, if your employer sponsors a 401(k), 403(b) or a 457 qualified retirement plan, and if that plan offers a Roth option, you could contribute to the Roth account instead of the pre-tax account as there is no income limit on these types of Roth savings vehicles. You could even contribute simultaneously to both the Roth and the pre-tax account if desired as long as your total contribution did not exceed the annual salary deferral limit. That limit for 2021 is $19,500 if under age 50, and $26,000 for those over age 50. If your employer’s plan allows it, you could also transfer some of your pre-tax plan assets to your plan’s Roth option. You would incur a tax upon this type of transfer, so you should fully understand the estimated tax consequences and your ability to pay them.
Another strategy is to contribute to a traditional IRA and then later transfer those funds from that IRA to a Roth IRA. This strategy is commonly referred to as a backdoor Roth conversion and has been gaining in popularity over the past several years. It may create a taxable event depending on the initial IRA contribution status (pre-tax or after-tax) and if the funds converted to the Roth IRA grew in value before being transferred. Additionally, some high-income earners currently contribute to after-tax savings accounts within their employer’s qualified retirement plan (if offered) and then convert those funds to the Roth account within the plan. This strategy is referred to as a mega backdoor Roth conversion because the contribution limits to after-tax savings accounts can be much higher than pre-tax accounts.
IRS regulations currently allow for such Roth conversions; however, these backdoor options are thought by many to have been oversights by Congress allowing otherwise non-eligible wage earners to sock money away in Roth accounts. As such, Congress is starting to address what it considers to be a loophole in the law’s original intent. The Build Back Better bill recently passed by the House of Representatives and now being debated in the Senate closes this loophole. As currently written, Roth conversions of after-tax savings through traditional IRAs or 401(k) plans will no longer be allowed after 12/31/2021 and pre-tax savings converted to Roth IRAs or Roth 401(k) accounts will be prohibited after 12/31/2031 for those in higher income brackets.
Of course, this is all subject to change and the bill might not even pass, but then again it may. Anyone considering a backdoor Roth conversion may not have much longer to take advantage of this unique method of converting money into tax-exempt status. Please consult your personal tax advisor about the merits of a Roth conversion in your specific situation as Wealthview Capital does not provide tax advice.