- A popular retirement savings strategy is on the chopping block in Congress, and investors have been eyeing the strategy before it disappeared.
- Those considering a backdoor Roth individual retirement account will need to weigh several factors — upfront bills, future tax brackets, waiting periods and the consequences of increasing income.
A popular retirement savings strategy is on the chopping block in Congress, and investors have been eyeing the strategy before it disappeared. But financial experts say there are other things to consider before making changes.
Currently, investors can skirt income limit to a Roth individual retirement account by using a so-called backdoor.
Investors make what are known as non-deductible contributions to their traditional IRA before converting the fund to their Roth IRA. Tax-free growth in the future may be attractive if they expect a higher bracket in retirement.
More from Personal Finance:
What to do if Democrats ax the backdoor Roth IRA strategy?
How to Avoid Individual Retirement Account Deduction Mistakes
These year-end tax moves could help you save, regardless of Congress’s moves
House Democrats want to crack down on after-tax strategy, regardless of income level, after December 31, according to the House Ways and Means Committee Summary.
While some investors are eager to complete the move before the end of the year, advisors urge caution, especially with the law in flux.
“It’s one of those things you can’t see in a vacuum,” said Marianella Collado, certified financial planner and CPA at Tobias Financial Advisors in Plantation, Florida. Investors need to take a holistic approach.
Roth conversions can trigger pre-tax contributions or levies on earnings, so investors will need a plan to cover the bill.
“You need to be mindful of what you’re going to tax on a conversion basis,” said Ashton Lawrence, a CFP at Goldfinch Wealth Management in Greenville, South Carolina.
In addition, anyone willing to pay advance taxes on Roth conversions may need to project how many years it will take until they break through, Collado said.
However, some investors opt for taxable Roth conversions in years with lower income or other deductions to offset the levy.
While Roth IRAs generally offer tax- and penalty-free withdrawals at any time for contributions, there is a exception to conversionknown as the “five-year rule”.
Investors, regardless of their age, must wait five years before withdrawing the converted balance, or they will incur a 10% penalty. The timeline starts on January 1st of the year of conversion.
Another potential downside of a Roth conversion is its ability to increase that year’s adjusted gross income, which could lead to other issues, Lawrence said.
“It’s like a balloon,” he explained. “If you squeeze it on one end, you’ll inflate it somewhere else.”
Anyone with a modified adjusted gross income of more than $88,000 ($176,000 for joint filers) will have an additional surcharge each month, known as an income-related monthly adjustment amount, or IRMAA.
In 2021, additional fees for Medicare Part B and Part D could be as much as $504.90 and $77.10, respectively.