Retirement options have evolved over the last few decades. It used to be that you worked at a company your entire career, and when you retired they paid you a pension for the rest of your life. Although there are pensions around today most of them are fractions of what they used to be, and most people these days have a 401k in place of a pension. What happens when you max out your 401k?
One option to suppliment your 401k is an Individual Retirement Account (IRA). The IRA allows individuals to save for retirement outside of a company sponsored plan with two types of IRAs: Traditional and Roth. The Traditional IRA provides a tax deduction for contributions and tax deferred growth. The Roth offers tax free growth, but you do not get a tax deduction for contributions. You and your spouse can each make contributions to an IRA up to $5,500 ($6,500 if you are age 50 or older). Unfortunately there are limitations on the tax benefits of these types of accounts based on your income. However, there is a loophole that allows you to receive some tax benefits even if you are above these income limitations.
If you are maxing out your 401k most likely you are exceeding the income limitation for the tax deduction of contributing to a Traditional IRA. If you exceed the income limitations the IRS allows you to make contributions to a Traditional IRA up to the regular contribution limit however these contributions are not deductible. Roth IRAs have a more strict income limitation which prevents individuals making any contribution to these accounts at all if they make too much money.
Now for the good news… A few years ago the IRS removed the income limitation on Roth IRA conversions. This allows you to convert your existing Traditional IRAs into a Roth IRA even if you are precluded from making contributions directly to a Roth. This opens up a loophole for taxpayers who cannot make deductible contributions to a Traditional IRA or make any contributions to a Roth IRA. This essentially allows you to receive the tax benefits of a Roth IRA even if you are excluded from making direct contributions to a Roth.
In order to take advantage of this strategy you must make a contribution to a Traditional IRA and then have your broker roll that account over to a Roth IRA before the end of the year. As with most tax strategies there are circumstances specific to each individual that determine how well the strategy would work for them. If you think you could benefit from this tax saving strategy contact your MKS&H tax advisor today and we will help you determine if this is the right strategy for you.
Article Provided By Brian Patrick, CPA, MKS&H In-Charge Accountant
About MKS&H: McLean, Koehler, Sparks & Hammond (MKS&H) is a professional service firm with offices in Hunt Valley and Frederick. MKS&H helps owners and organizational leaders become more successful by advising them regarding their financial, technology and human capital management needs. Please visit www.MKSH.com for more information.