The contribution limits and income thresholds for 2021 have been released by the IRS. As these accounts can represent a substantial portion of your retirement nest egg, it makes sense to take advantage of the tax breaks for contributions today and maximize your income when you are ready to retire.
In terms of amounts that can be contributed, there are no increases for the main types of retirement plans (Traditional IRA and Roth) for 2021. However, some of the AGI thresholds have been adjusted for inflation.
Traditional IRA contributions are fully deductible regardless of income level
However, where the taxpayer, or the taxpayer’s spouse, are covered by a qualified plan with an employer, the deductibility of the contribution may be limited or lost entirely. The deduction for the contribution starts to be limited (“phased-out”) at modest income levels - where the taxpayer is covered by a retirement plan at work it is $66,000 if single, $105,000 if Married Filing Jointly - or where the taxpayer’s spouse is covered by a plan at work - $196,000. In situations where these income thresholds are exceeded, consider the “Back Door” Roth conversion strategy below.
Married taxpayers each can contribute to their own IRA
For those filing joint returns, there is no earned income requirement for IRA contributions made by a non-working spouse if earned income of the couple exceeds the combined IRA contribution amount. But remember, each spouse must have their own dedicated IRA account to use this strategy.
Fund Roth IRA Accounts
Roth IRAs can grow tax free indefinitely and can be accessed free of tax in retirement. There are no Required Minimum Distributions (RMDs) applied on Roth accounts. Contributions can be made up to $6,000 ($7,000 if over 50) from earned income. Roth contributions are subject to income limits – see chart.
Convert Traditional IRA Accounts to Roth IRAs
Convert Traditional IRAs to Roth IRAs accounts where they can grow tax-free indefinitely remember, no RMDs are required for Roth accounts. Unlimited amounts can be converted to a Roth under this strategy however the conversion is considered a taxable event. Roth conversions work best in years with lower total income.
“Back-Door” Roth IRA Conversion
Consider a back-door Roth Conversion when income exceeds the Roth contribution limits or where no tax deduction is possible with a Traditional IRA because the taxpayer or spouse has a plan at work. Under a “Back-door Roth”, you make contributions to a Traditional IRA on a post-tax (non-deductible) basis, then convert that Traditional IRA to a Roth IRA without tax consequences. End result is that you have side-stepped the income limits on Roth contributions.
Separate pre-tax and post-tax IRAs accounts
Roth conversion strategies may be less effective where there are both pre-tax and post-tax funds within the same IRA account or across different accounts. In this situation, contribute the pre-tax portion of IRA account(s) to an “active participant” employer plan if you have one, such as a 401(k), and then convert the clean post-tax remainder(s) to a Roth IRA. Both transactions can be achieved on a tax-free basis.
And remember, from 2020 onwards, the previous age limit of 70.5 on IRA contributions is removed!
As you go through your transitions, know that BakerAvenue is here for you and your family. Contact us for additional retirement planning questions you may have.
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