Page 76 - August 2015 Life In Naples Magazine

FINANCE
The Backdoor ROTH UNVEILED
by Steven T. Merkel
CFP®, ChFC®
W ithout hesitation, most financial professionals will
unarguably agree that the Roth IRA is hands down
the best individual retirement arrangement on the
planet. Benefits such as tax-free growth, no RMD
requirements at age 70 ½,and penalty-free early withdrawal of principal
are just a few of the many benefits. But to date… it is the only IRA
retirement plan that offers 100% tax-free withdrawals of principal and
earnings after age 59 ½, provided that the Roth was established for at
least five years before the distribution occurs. Why wouldn’t everyone
have one?
LIMITATIONS AND RESTRICTIONS
Eligibility to contribute directly to a Roth IRA is phased out at certain aggregate IRA values down to zero, you can then utilize the Backdoor
modified adjusted gross income (MAGI) levels. Roth contribution
eligibility (indexed for 2015) ends at MAGI limits for single tax filers
at $131,000 and $193,000 for those married filing jointly. If you have
earned income under these MAGI levels, you can contribute directly to
a Roth for both you and your spouse - at a maximum of $5,500 each
per year or $6,500 if you’re age 50 or older.
In 2010, the government removed the $100,000 income limitation
for Roth conversions.Roth conversions allow taxpayers to convert full or
partial Traditional IRA funds (both deductible and non-deductible) to
Roth IRAs by paying tax on the untaxed amount converted in the year
of conversion. The removal of this rule also opened up some amazing
strategic planning opportunities for both low and high income earners.
BACKDOOR ROTH
If your earned income MAGI exceeds the direct contribution limits
to the Roth IRA, there’s still a possible solution for you. The IRA rules
allow those individuals that can no longer benefit from deductible IRA
contributions to make non-deductible contributions to a Traditional
IRA (make sure your CPA files Form 8606 with your tax return to
acknowledge the non-deductible contribution). Immediately after your
contribution posts to your non-deductible IRA, you should convert
the funds to your Roth IRA account. Presto… you now have a Roth
IRA and you converted it without paying any tax! How? There were
no earnings in the non-deductible Traditional IRA at the time of
conversion and you never took any tax deduction for the contribution,
so there was nothing new there for the IRS to tax since your initial
contribution was comprised of after-tax dollars.
WATCH OUT FOR THE PRO-RATA RULE
The catch to this strategy is if you already have existing IRA
accounts. In this case, the IRS would look at the aggregate value of all of
your Traditional IRA accounts and tax the amount of your conversion
based as a percentage of the overall value of all of your IRA accounts.
This is not the best scenario because you would still owe some tax on
the conversion amount based on the pro-rata formula. If conversion
still interests you, keep in mind that you do not have to convert the
entire IRA to a Roth in the same tax year, so many individuals are still
able to spread the tax consequence over several years by only converting
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a partial amount of their deductible (taxable)
IRAs each year.
AVOIDING THE PRO-RATA RULE
Should you desire to reduce your pre-tax
IRA values to zero in order to avoid paying tax
on the conversion amount, you could consider
rolling over your IRA accounts into a 401K plan
prior to opening a non-deductible IRA. Since
many employers do not allow outside pre-tax IRA monies to rollover
into their plan, if you have self-employment or 1099 income, consider
opening a Uni or Solo 401K to rollover the funds. If you get your
Roth with no tax due.
The Backdoor Roth is an excellent strategy if you do not have any
existing pre-tax Traditional IRA accounts or you’re able to rollover
those funds into a 401K account.The ability to convert non-deductible
IRA funds to a Roth IRA tax-free is an amazing tax and investment
strategy that can provide family generations of tax-free earnings and
distributions. There’s no other product out there like it. Even retirees
with no earned income may want to consider partial Roth conversions
(paying tax now on the conversion amount of course). So what are you
waiting for? Contact your financial planner today to fully understand
your personal tax situation and then get the ball rolling on this incredible
opportunity before the IRS fully catches on and makes changes to the
tax code.
Steven T. Merkel CFP®, ChFC®
www.CASMoneyMatters.com
Ciccarelli Advisory Services, Inc. is located at 9601 Tamiami
Trail North, Naples, FL (239.262.6577)
Investment advisory services offered through Ciccarelli Advisory
Services, Inc., a registered investment adviser independent of FSC Securities
Corporation. Securities and additional investment advisory services offered
through FSC Securities Corporation, member FINRA/SIPC and a registered
investment adviser.
A Roth IRA distribution is qualified if you’ve had the account for at least
five years and/or the distribution is made after you’ve reached age 59½, due
to total and permanent disability, in the event of your death or for first-time
homebuyer expenses. Distributions made prior to age 59 1/2 may be subject
to a federal income tax penalty. If converting a traditional IRA to a Roth IRA,
you will owe ordinary income taxes on any previously deducted traditional
IRA contributions and on all earnings. A conversion may place you in a higher
tax bracket than you are in now. Since Roth IRA conversions may not be
appropriate for all investors and individual situations vary we suggest that you
discuss tax issues with a qualified tax advisor. There are several choices investors
have when rolling over money from one plan to another. Since each choice
has its own implications, it is recommended that you discuss and compare all
potential fees, expenses, commissions, taxes, and legal ramifications with your
qualified advisor before making a rollover decision.
Life in Naples | August • September • October 2015