IRA admission, tax breaks for high earners could be phased out
IRA has a Annual contribution limit $7,000 2024.
Investors who contribute to a pretax IRA often receive a tax deduction based on their contributions. However, they typically pay income tax on earnings and withdrawals. Roth contributions don’t get the same upfront tax break: Investors fund a Roth IRA with after-tax dollars, but generally don’t pay income tax on the earnings or withdrawals in retirement.
However, many high-income earners are unable to take full advantage of these tax-advantaged accounts.
For example, a married couple filing a joint tax return cannot contribute to a Roth IRA in 2024 if their Modified Adjusted Gross Income is $240,000 or more. this revenue threshold The fee for a single filer is $161,000. (Eligibility begins to phase out even before these dollar thresholds are reached, reducing the amount investors can contribute.)
Likewise, there are income limits Regarding pre-tax (also known as “traditional”) IRA deductions, for those who also Can access Workplace retirement plan, such as 401(k).
For example, a single filer with income of $87,000 or more in 2024 will not receive a tax deduction for traditional IRA contributions if they have a retirement plan at work.
The same applies to Married couple filing jointly. For example, if your spouse participates in a 401(k) plan at work and your joint income is $240,000 or more, you will not get a deduction for IRA contributions. If you are participating in a workplace 401(k), the limit is $143,000. (Again, because of the income phase-out, you may only be able to get a partial deduction below these dollar thresholds.)
The “Only Reason” to Contribute to a Nondeductible IRA
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However, high-income earners can contribute to so-called nondeductible IRAs.
This is a traditional IRA, but investors don’t get a tax deduction for their contributions; they fund the account with after-tax dollars. Investors are required to pay growth income tax upon exit.
Tax experts say the ability to use a backdoor Roth IRA is a major benefit of these accounts.
It’s only available to investors who make too much money to contribute directly to a Roth IRA or to a traditional IRA, Slaughter said.
The basic strategy is as follows: A high-income investor will make a nondeductible contribution to his traditional IRA and then Quickly convert funds to their Roth IRA.
“The only reason you do it (a nondeductible IRA) is if your purpose is to do a backdoor Roth,” Slaughter said.
After making nondeductible contributions, Slott recommends waiting about a month before converting the funds to a Roth IRA. This, he says, ensures that your IRA statement reflects nondeductible contributions in case the IRS asks for proof.
Some investors may also be able to take advantage of a similar strategy in their 401(k) plans, known as a large backdoor Roth conversion. This requires transferring after-tax 401(k) contributions to a Roth account. However, this strategy doesn’t work for everyone.
“All high-income earners who are unable to set up a Roth IRA should consider both a backdoor Roth IRA and a large backdoor Roth IRA,” said Ted Jenkin, a certified financial planner and founder of oXYGen Financial in Atlanta and a CNBC contributor. Member of the Financial Advisory Committee.
When a Nondeductible IRA Doesn’t Make Sense
Financial advisors say a nondeductible IRA may not make sense for investors who don’t plan to take advantage of a backdoor Roth strategy. In this case, the investor simply keeps the contribution in a nondeductible IRA.
For one, nondeductible IRA contributions can come with onerous administrative and record-keeping requirements, Slaughter said.
“It’s a life sentence,” he said.
Taxpayers must submit a Form 8606 Track their after-tax contributions to a nondeductible IRA with the IRS each year, according to Arnold & Mote Wealth Management, headquartered in Hiawatha, Iowa. It added that the withdrawals “add to the complexity of administrative enhancements”.
Why a taxable brokerage account is “probably better”
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Without a backdoor Roth, most investors would be better off depositing into a taxable brokerage account rather than depositing into a nondeductible IRA, advisers say. This is because investors who use the former may end up paying less tax on their profits in the long run.
Taxable brokerage accounts are “probably better in most ways,” Slaughter said.
Investors who generally hold assets such as stocks in a taxable brokerage account for more than one year Pays a preferential tax rate on its profits relative to other income taxes.
These “long-term” capital gains rates (which only apply in the year the investor sells the asset) are as high as 20% at the federal level. (Higher earners may also owe 3.8%.”Medicare surtax“About profit.)
By comparison, the top marginal income tax rate is 37%. Investors in nondeductible IRAs are typically subject to higher interest rates on their earnings when making withdrawals.
While taxable brokerage account investors pay taxes every year in dividend incomeSuch taxes are often not enough to offset the relative tax benefits of such accounts, advisers say.
“The tax deferral for nondeductible IRAs may be an advantage for some,” according to Arnold & Mott Wealth Management. “However, we found this to be quite rare.”
Additionally, investors in taxable brokerage accounts can generally withdraw funds at any time without penalty, whereas IRAs often come with tax penalties When income is tapped before age 59.5. (However, there are some IRA exceptions.)
Unlike traditional and nondeductible IRAs, taxable accounts have no required minimum distributions while the account holder is alive.
“Taxable accounts provide the flexibility to add funds to and withdraw funds with few restrictions, penalties or restrictions,” said Judith Ward, a certified financial planner at asset management firm T. Rowe Price. wrote recent.
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