Roth IRAs can be a powerful tool to accumulate post-tax retirement savings, achieve tax-deferred investment growth, and receive tax-exempt withdrawals in retirement. However, contribution limits can make it difficult to maximize savings and access a tax-exempt source of retirement income.
In 2023, individuals can contribute up to $6,500 per year to a Roth IRA ($7,500 for those age 50 and older). The maximum contribution is reduced for individuals whose modified adjusted gross income (MAGI) is more than $138,000 ($218,000 married filing jointly), and no Roth IRA contributions are allowed for individuals with a MAGI of $153,000 or more ($228,000 married filing jointly).
Similarly, Roth contributions to an employer-sponsored retirement plan are limited to $22,500 in 2023, with an additional $7,500 permitted as a catch-up contribution for those age 50 and older.
If you find your options restricted by Roth contribution limits, there are still several strategies that can help you optimize your retirement savings.
1. Consider a backdoor Roth IRA.
If your income exceeds the limit for direct Roth IRA contributions, a “backdoor” Roth IRA strategy can be an effective option. This involves establishing a traditional IRA alongside your Roth IRA. You can make the same $6,500 ($7,500 for those age 50 and older) contribution to your traditional IRA on an after-tax basis. This means you don’t take a tax deduction in the current year for contributing to the IRA account. You then convert the funds from the traditional IRA to the Roth IRA.
Because there are no income limits for traditional IRA contributions on an after-tax basis, this allows high-income earners to contribute to a Roth IRA. Because the traditional IRA contributions were made with after-tax funds, this strategy is allowed by the IRS.
2. Consider a “mega” backdoor Roth.
This strategy takes the backdoor Roth IRA to a new level, allowing individuals whose income exceeds IRS limits to supercharge their after-tax retirement savings. The strategy involves two steps:
Make after-tax contributions to your employer-sponsored retirement plan, such as a 401k. And complete an in-plan conversion of the after-tax assets to a Roth IRA or Roth 401k.
In 2023, the IRS allows individuals to contribute up to $43,500 in after-tax assets to an employer-sponsored retirement account, assuming you’re not eligible for an employer matching contribution (if you receive an employer match, you’ll need to deduct any employer contributions from $43,500 to determine your maximum contribution amount). You can then convert those assets directly into a Roth IRA or 401k to help optimize your after-tax retirement savings.
3. Establish a spousal Roth IRA.
If you’re married and your spouse doesn’t make earned income, you may want to consider opening a spousal Roth IRA. This strategy allows you to contribute to a Roth on behalf of your spouse, essentially doubling your combined savings potential. Be sure you meet the income requirements and adhere to contribution limits for both your account and your spouse’s.
4. Take advantage of your Roth 401k.
While not a direct solution for overcoming Roth IRA contribution limits, contributing to a Roth 401k can be a viable alternative for high-income earners to accumulate after-tax retirement savings. Unlike a Roth IRA, Roth 401ks don’t impose income limitations. If your employer offers a Roth 401k option, it may make sense to max out your contributions to take advantage of tax-deferred growth and tax-exempt withdrawals in retirement.
5. Fund a Roth IRA for your child with unused 529 plan assets.
The Secure Act 2.0, passed in 2022, included a provision allowing unused 529 plan dollars to be converted to Roth IRAs for a beneficiary without incurring any taxes. The 529 account must have been open for 15 years, and the lifetime amount that can be converted from the plan to a beneficiary’s Roth IRA is $35,000. The amount converted per year is subject to the same eligibility rules as making outright Roth contributions.
It’s important to note these strategies present various financial complexities that, if not properly planned for, can lead to additional tax liabilities. Be sure to work with a qualified wealth advisor to execute them and protect your retirement savings.
Gene Gard, CFA, CFP, CFT-I, is a Partner and Private Wealth Manager with Creative Planning. Creative Planning is one of the nation’s largest Registered Investment Advisory firms providing comprehensive wealth management services to ensure all elements of a client’s financial life are working together, including investments, taxes, estate planning, and risk management. For more information or to request a free, no-obligation consultation, visit CreativePlanning.com.
