The Key to Your Roth IRA Might be Under the Mat

I venture to guess that most of us have been locked out at least once in our lives. Whether it was a car or your home, missing keys prohibited your access. Because nothing is more frustrating or annoying then when this happens, we come up with creative solutions to ensure that we can get in when we want to, like hiding a key under a door mat.

This week I would like to blog about a little known investment strategy that Secured Retirement Advisors is using with local families who wish to take advantage of tax-free retirement planning. The Roth IRA was created in 1997, and since this time, many higher income families in the Twin Cities they have been locked out of the opportunity to make Roth “contributions”.  The advantage of this saving alternative is that it allows money to grow and be withdrawn tax-free. The good news is that Congress eliminated income limits on Roth “conversions” in 2010 which left a key under the mat, allowing all working Minnesotans the option of making Roth contributions.

To understand how this hidden key works, we want to first clarify the often confusing difference between a “Roth Contribution” and a “Roth Conversion”.

Roth Contributions are limited to either $5,000 dollars per year if you are under age 50 or $6,000 dollars if you are age 50 and older. Think of Roth Contributions as money paid into a Roth plan from your checkbook. This means that a married couple nearing retirement can write a check and generally contribute $6,000 dollars each or $12,000 dollars as a family, as long as they meet two requirements. 1) Have earned income from wages or self employment (excluding social security, pensions, rental income, interest and capital gains). Even if one of the spouses is not working, a married couple can make their maximum contribution as long as at least one of them has the required income.  2) They must be below the adjusted growth phase-out provisions. At this point, higher earning income families run into the locked door. This phase-out provision for the 2011 tax year started at $107,000 dollars for single families and $169,000 dollars for married filing-joint families. Because their income may exceed these levels, many families assume that they are locked out of options for a Roth.  This is when it pays to know where to find the key.

Since 2010, all families regardless of income are now eligible to make a Roth Conversion, provided that they have an eligible retirement plan to convert from. Unlike the Roth Contribution which comes from a checkbook, the Roth Conversion must come from funds already sitting in a qualified retirement plan such as an IRA, 401k, 403b, etc. Taxes are due from the funds converted in the year that conversions are made – but read on!!!

Prior to 2010, a Roth Conversion also had income phase-out rules as well, but these have been eliminated, creating an opportunity for many families to set aside money each year into a Roth plan regardless of income level. This is the key under the mat I have been talking about for higher income families to take advantage of their Roth IRA this year.

Roth IRA Example

Knowing where to find the hidden key is good but knowing exactly how to use it is better, so I would encourage you to visit with your tax or financial advisor prior to implementing the plan described below. Imagine we have a married couple, both over age 50, who exceed the phase-out threshold of $169,000 dollars of income but would like to set aside $12,000 dollars this year into a Roth IRA. By using the key under the mat (the changes in the 2010 Roth Conversion limits) they are now eligible to take advantage of this fantastic savings plan. They first contribute after-tax money into a traditional IRA. (Note this is after-tax money and you will not get the write off on your return.) Then, because Congress now allows unlimited conversations from IRA plans into Roth IRAs, convert these funds into a Roth IRA. No tax will be due because the funds used to make the Roth IRA were “after-tax” contributions.

Full implementation of this strategy will have to wait until you file your 2012 taxes, because it is too late to make a Roth Conversion in 2011, but it’s not too late to make your non-qualified IRA contribution. So to take advantage of this strategy you may want to consider doing the following:  Contribute both your 2011 and 2012 non-qualified contributions today – you only have until April 17 to do this for 2011.  This would allow the couple in the example above, the opportunity to contribute $12,000 dollars in 2011 and an additional $12,000 dollars for 2012. Next, simply convert the $12,000 dollars each of his and hers contributions into Roth IRA’s - and TahDah! This couple has now successfully moved $24,000 dollars into a tax free Roth IRA, without any additional taxes due except for that from the income already be paid off in the initial $24,000 dollars non-qualified IRA contribution.

There are several other strategies such as this that Secured Retirement Advisors can utilize to help families transfer money into tax-free assets, but due to space limitations we will need to go into that in a different blog.  Until then, if you would like a complementary “3 Step Review” of your own retirement plan, call Secured Retirement Advisors at 952-460-3260.