Roth IRAs have grown significantly in the past decade as tax law has broadened access for investors. Offering tax-free withdrawals in retirement, Roth IRAs can provide tax diversification in retirement and hedge the risk of higher tax rates in the future.
While all taxpayers can convert traditional IRA assets to a Roth, contribution rules based on income still apply to Roth IRA contributions. A full contribution is allowed only if adjusted gross income is less than $120,000 for individuals or $189,000 for married couples filing jointly. For those who can contribute annually, the amount is fairly modest — $5,500, or $6,500 for those age 50 and older.
However, there may be an opportunity to contribute significantly more — or to “super-fund” — a Roth IRA without any restrictions based on income level. If an investor’s 401(k) plan allows for after-tax contributions, the limit is higher and these assets may be eventually rolled over into a Roth IRA.
The following example illustrates how this could work.
Assume the retirement plan allows participants to make after-tax contributions.
- Assume the participant maximizes pre-tax deferrals of $18,500
- The employer provides an employee match of $5,000
- Total contribution of $23,500 in the retirement plan
- The rules provide that the overall limit on annual additions into a retirement plan — known as the 415 limit — is $55,000
- If the plan allows for after-tax contributions, that means an additional maximum of $31,500 could be contributed
- Upon a “triggering event” for the plan, such as separation of service, or attaining age 59½, after-tax contributions in the plan could be rolled directly into a Roth IRA
- Guidance from the Internal Revenue Service in 2014 clarifies how the rollover works
Policy moves have helped Roth IRAs grow
Roth IRAs have grown significantly since a tax law took effect in 2010 that eliminated income thresholds for the completion of a Roth IRA conversion. This provision allowed all taxpayers the option of converting traditional IRA assets to a Roth IRA. Since this tax law was implemented, assets in Roth IRAs have more than tripled to $810 billion in 2017 from $238 billion in 2010, according to the Investment Company Institute. Roth IRA assets as a share of total IRA assets jumped to 9% from 5% over the same time period.
Investors considering a Roth IRA rollover need to understand the details of the rule including how much and when assets can be rolled over. Establishing tax diversification of retirement assets may help in managing income and tax liability in retirement. Consider discussing these strategies with a financial advisor who has an understanding of your individual financial situation.