3 Powerful Roth IRA Conversion Strategies for 2020

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By J.P. Dahdah, Founder & CEO of Vantage

I was a newly licensed financial advisor starting my career after graduating from The University of Arizona when the Roth IRA was created and brought to market by Congress in 1998 through the Taxpayer Relief Act of 1997. It’s crazy that more than 20 years have gone by since this powerful retirement savings vehicle was born, and yet, it doesn’t get the respect and attention it deserves. Even given the immense tax benefits it offers, Roth IRAs have only been able to attract $880 billion, which is only 8% of all the money currently held in IRAs, according to the Investment Company Institute.

Roth IRA benefits

The fact that withdrawals from Roth IRAs are completely tax-free and they don’t disrupt any of your social security benefits or Medicare costs, you would assume everyone would be rushing to figure out how they can open, fund, and build their Roth IRA balances. Ironically, it’s just not so. Being bullish on making Roth IRA contributions does require a behavioral trait not commonly found in investors, accepting short-term pain (no current tax deduction) in return for long-term gain (tax-free distributions). Our society these days is so accustomed to getting instant gratification for things, that any strategies that require patience and time to benefit from are rarely preferred.

Roth IRA Limitations

The other hurdle high-income earners are faced with is they aren’t eligible to make Roth IRA contributions even if they wanted to due to the income limitations placed on them. This year, for example, you can’t have modified adjusted gross income above $139,000 (singles) or $206,000 (married filing jointly) to qualify. To add insult to injury, the maximum contribution limit for investors under the age of 50 is a mere $6,000 and $7,000 if you are over 50 years old. The ability to contribute larger amounts into employer-based qualified retirement plans, such as 401Ks and Roth 401Ks, is yet another reason why so many Americans opt to participate in those plans over Roth IRAs.

Is your retirement savings falling behind?

Since the majority of people haven’t created well-established savings habits early enough in life, they need to “catch-up” on their retirement savings and seek accounts that make it easier to contribute larger amounts. If you are interested in getting the best of both worlds, larger contribution limits, and tax-free growth, it’s important to note that according to the Plan Sponsor Council of America, 60% of workplace 401K plans allow employees to initiate after-tax or Roth-style salary deferrals (i.e. Roth 401K plans).

3 Conversion Strategies to Supercharge a Roth IRA

Okay, I’ve spent enough time sharing some of the reasons why Roth IRAs haven’t shined up to their potential. Now it’s time to provide a few ways that can help you purposefully embrace the power these tax-efficient vehicles offer and load them up with as much of your retirement savings as possible.

1.  Roth conversion via valuation discounting:

One of the biggest positive windfalls into Roth IRA balances occurred in 2010 when the government passed legislation to eliminate the $100,000 income restriction which previously prevented high-income earners from converting regular IRA money into a Roth.  Even though prudent tax planning is required prior to implementing a Roth conversion, alternative asset Self-Directed IRA account holders are the best-positioned investors to take advantage of advanced tax minimizing strategies through a Roth conversion.  This is because the fair market value of alternative assets can be decreased as much as 40% through IRS-allowable discounting.  Please read my prior blog on “Valuation Victories” to learn more about this unique and impactful strategy.

2.  Mega-backdoor Roth conversion via maximum pre-tax contributions:

Unlike the conversion mentioned above, this conversion strategy allows employees to possibly convert larger sums into a Roth IRA after contributing the $19,500 maximum – or $26,000 if you are 50 years old or older – to a traditional pre-tax 401K.  In total, the IRS allows workers to put away up to $57,000 a year in pre-tax, after-tax, and employer contributions- or $63,500 if you are 50 or older.  This also includes contributions into a SEP IRA, which along with Solo 401K plans are viable retirement plans to consider for this strategy.  Even though the rules vary between 401K plans and SEP IRAs, the concept still applies with either type of plan.  Essentially, you take advantage of their higher contribution limits, and then turn around and covert the pre-tax account into a Roth IRA.

3.  Backdoor Roth Conversion via rollover:

Keep in mind that a large portion of workplace 401K plans allow employees that have reached the age of 59 ½ or older to roll over their balances into a traditional IRA, which can then be converted to a Roth.  Some plans even allow younger employees that have made after-tax contributions the ability to withdraw solely their after-tax money, pay tax on the earnings, and convert the withdrawal amount into a Roth IRA. This helps younger savers begin to grow their tax-free retirement portfolio super early which is a big advantage over their older saving counterparts.

In case you haven’t realized, I love Roth IRAs and I hope my passion for them can help you begin to share my respect for them. Implementing the above-referenced strategies has enabled me to grow a healthy six-figure balance in my Roth IRA/401K accounts. I strategically direct my Roth IRA funds into the alternative assets I expect will appreciate greatly so that when I decide to live off some of my retirement plan money, I can withdraw my income from various tax-free buckets helping me minimize my tax exposure during retirement.

Lastly, the fact that 2020 is an election year increases the importance of evaluating Roth IRA conversion strategies because tax rates have the potential of being increased. If you expect your income tax rate may go up, taking assertive action on a Roth IRA conversion now may save you a higher level of taxation being imposed later.

If you aren’t utilizing a Roth IRA in your retirement planning, I hope this article motivates you to taking a closer look as to how it can benefit you now and in the future. Please contact us if you have any questions or would like to speak to someone about your retirement planning. 

Happy investing!