Clearing the AIR on IRAs (Part II)

[Continued from last week's post]

There are too many rules on IRA contributions and limits to summarize in this format, but here I'll discuss some of the most commonly referenced ones for my typical clients.

Roth IRAS

  • After-tax contribution and Spousal IRA contribution - this is an annual contribution strategy with income limitations and contributions caps. You can deposit money that has already been taxed into your Roth IRA and achieve tax-free growth. The 2017 contribution cap is $5,500 ($6,500 if you're over age 50) or your taxable compensation for this year. Married filing jointly allows for couples to contribute for both spouses assuming enough taxable comp even if only one spouse works.
  • Pre-tax conversion - this is typically a one-time strategy (or maybe divided over a few years) to transfer funds from a traditional IRA into a Roth IRA. You might have a lower-than-usual income for a few years and paying taxes now from after-tax savings isn't a burden. There is currently no limit to the number of conversions or the amount that you can convert.
  • After-tax conversion - this is commonly referred to as a "Back Door" conversion because it's typically used by high earners who are disallowed from after-tax Roth contributions. If you have no traditional IRA money (or you've rolled all IRA money into your employer 401(K) plan), then after-tax IRA contributions made to your IRA open up the potential for a clean, after-tax Roth conversion at a later date that results in no new taxes owed.

Traditional IRAs

  • Deductible (pre-tax) IRA contribution and Spousal IRA contribution - this is an annual contribution strategy with income limitations and contributions caps. The deductibility of the contribution also depends on whether or not you (and/or) your spouse are covered by retirement plans through your work. There are way too many layers to analyze, but the most basic example of a married filing jointly status and income under $98,000 means you could make a full contribution and deduct the entire contribution amount. The 2017 contribution cap is $5,500 ($6,500 if you're over age 50) or your taxable compensation for this year. Married filing jointly allows for couples to contribute for both spouses assuming enough taxable comp even if only one spouse works.
  • After-tax IRA contribution - this is an annual contribution strategy with contribution caps only and most common for those attempting to achieve back-door Roth conversions. If that's the case, you must first make sure that you hold no other pre-tax IRA funds by rolling them in to an employer retirement plan, such as a 401(K). Keeping after-tax contributions in an IRA can grow to be fairly complicated because the growth is taxed upon withdrawal and the original contribution is not. You'll have to stay on top of how much you've contributed over the years to properly adjust your withdrawals (pro-rata) in retirement for after-tax contributions vs. pre-tax growth.

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Beneficiaries and estate planning.