A well-respected tax and estate planning attorney recently told me he had no idea he could contribute to a Roth 401k. He was sure there was an income limit. He and many others are missing a great investment opportunity.
For years we have been wired to defer taxes and pay only when it is absolutely necessary. Roth 401k and IRA accounts turn that logic on its head, encouraging taxes to be paid today in exchange for tax free benefits later.
Created by Congress on Jan. 1, 1998 as part of the Taxpayer Relief Act, the Roth IRA is still a youngster from an historical investment perspective. For example, the traditional IRA was created in 1974 and the New York Stock Exchange was formed in 1792. The Roth 401k, created in 2006, is newer still.
The Roth accounts offer several unique benefits. One very attractive advantage is that the investment earnings are tax free, with the exception of early withdrawals. Earning must remain in a Roth account for at least five years and until you have reached at 59 1/2.
There are also no required minimum distributions at age 70 1/2. The Roth IRA can build until death and be passed to your kids or grandkids, who must take distributions over their life expectancy. And if you need the money before you retire, you can always withdraw your contributions — but not earnings — without penalty or taxes.
In 2014, the contribution limit for Roth IRAs is $5,500 ($6,500 if you are over age 50). There are income limits, however. To contribute to a Roth IRA, a single taxpayer’s income cannot exceed $112,000, or $178,000 if filing jointly.
If a person wants to contribute more than $5,500, or makes too much money to qualify for a Roth IRA, an employer’s Roth 401k feature may be an option. There are no income limits and the contribution limit is $17,500 ($23,000 if you are over age 50).
A recent survey by Aon Hewitt revealed that just 51 percent of companies had a Roth 401k feature in their plan. If your employer doesn’t offer one, ask if they will add it to the plan. Several of my clients have been successful in their efforts to get this accomplished.
There are many ways a person can take advantage of the potential of Roth accounts. One is to split your savings between pre-tax investments and a Roth account – or accounts – to get the best of both worlds.
If you are over the income threshold, you can take the backdoor into a Roth IRA. Contribute to a non-deductible IRA and then immediately convert it to a Roth IRA. You will have the benefits of a Roth and no taxes due.
Roth IRAs can be set up for a minor if the child has earned income from babysitting, cutting grass, etc. If a 15 year-old deposits $500 into a Roth IRA and earns eight percent annually, that initial investment would grow to more than $23,000 by the time he or she reached age 65.
Look for opportunities to convert your existing IRA to a Roth IRA in years where you have very low taxable income from a job loss, recent retirement, business losses, etc. You will pay taxes on any amount not previously taxed, but the low income will lower the tax burden.
There are many individual factors to consider with Roth accounts. It is best to consult a tax advisor before making any decisions. Ideally, your financial advisor and tax advisor have a good working relationship.
Brad Keene is a Wealth Management Advisor, Portfolio Manager at Visionary Wealth Advisors. He is a CERTIFIED FINANCIAL PLANNER (TM), holds an MBA from St. Louis University and a B.S. in Finance from Eastern Illinois University. He has been advising clients since 1996 and is a lifelong Collinsville resident. Contact Brad at email@example.com