Roth IRA Strategies: Here’s Our Top 5 [Tax + Investment]


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You may have heard about how great Roth IRAs are. But are you aware of all the Roth IRA strategies?

A Roth IRA is a special type of individual retirement account that allows individuals to invest after-tax money, rather than pre-tax money, into a retirement account. The money invested into a Roth IRA can grow tax-free and be withdrawn tax-free during retirement.

In this article, we will discuss our favorite Roth IRA strategies. You may be aware of a few of them, but it’s unlikely you know about them all. Let’s get started!

  1. Traditional Backdoor Roth
  2. Mega Backdoor Roth
  3. Excess Roth Strategy
  4. Strategic Conversion

The basics

To be eligible for a Roth contribution, an individual must have earned income and fall within certain income limits. For the year 2021, an individual can contribute up to $6,000 to a Roth IRA if they are under the age of 50, and $7,000 if they are 50 or older. These limits may be subject to change in future years.

One of the main advantages of a Roth IRA is that the money invested can be withdrawn tax-free during retirement. This is in contrast to a traditional IRA, where contributions are made pre-tax, and withdrawals are taxed at the individual’s current tax rate. This can make a Roth IRA a more beneficial option for individuals who expect to be in a higher tax bracket during retirement. Additionally, Roth IRA contributions can be withdrawn at any time without penalty, although any earnings on those contributions may be subject to taxes and penalties if withdrawn before age 59 1/2.

Roth IRA Strategies

Another benefit of a Roth IRA is that there is no age limit for making a contribution, unlike traditional IRAs, which require an individual to stop making contributions at age 70 1/2. A Roth can be used as a long-term savings vehicle for retirement.

Roth IRAs also offer a lot of flexibility in terms of investment options. They can be invested in various assets, such as stocks, mutual funds, bonds, and exchange-traded funds (ETFs). This allows individuals to choose investments that align with their risk tolerance and goals.

It’s also worth noting that Roth IRA contributions can be converted into Roth IRA distributions at any time, a process known as a Roth Conversion. This process can benefit individuals in a lower tax bracket who want to take advantage of the tax-free withdrawals a Roth IRA offers.

In conclusion, a Roth IRA is a type of individual retirement account that allows individuals to invest after-tax money into a retirement savings account that can grow tax-free. Withdrawals during retirement are also tax-free. Roth IRAs offer many benefits, such as no age limit for contributions, the flexibility to choose from various investment options, and the option to convert traditional IRAs into Roth IRAs. It’s a significant savings vehicle for individuals looking to save for retirement and should be considered part of a comprehensive retirement savings plan.

While there is plenty of discussion regarding the benefits of a solo 401k, less time has been spent discussing using a Roth. Most people have heard of a Roth IRA, but not a Roth 401k. Many have even asked – is this even possible?

Well, it indeed is possible, and it is under-utilized. Typically, folks who want to maximize retirement contributions have been in higher tax brackets. In most situations, I wouldn’t recommend a Roth at higher tax brackets.

But if you think that tax rates are only going higher or if you believe that you will be in a higher bracket at retirement then a Roth may be a wise choice. It makes more sense to put money into a pre-tax account when you are in the 37% tax bracket as compared to the 10% tax bracket.

So what are self-employed people in lower tax brackets to do? This is where a Roth makes a lot of sense.

Roth 401ks are subject to the same employee contributions as normal 401ks. That is, $18,000 for employees below the age of 50 and $24,000 for those 50 and older. Most employers offer Roth 401k elective deferrals, but most employees just don’t take advantage of them.

401k plans have the option to allow Roth contributions. These funds must be tracked separately from regular 401k contributions. As long as the 401k adoption agreement has a Roth component you are in good shape.

Let’s look at an example of a real estate client who was looking to boost his retirement savings.

This client has approximately 50 rental properties. Also, he and his wife have a small amount of earned income as real estate agents.

The rental properties generate passive income for him. But as a result of depreciation expense, he does not have high taxable income. He even completed a cost segregation study on his rentals. His taxable income was only approximately $100,000 a year, but his cash flow was much higher. Good for him.

But for a married couple with two kids and $100,000 a year in taxable income, he finds himself in the 15% tax bracket. Now the 15% tax bracket is certainly not as good as the 10% bracket, but it is a far cry from the 39.6% bracket. At this rate, pre-tax 401k contributions just don’t make as much sense.

For a self-employed person looking to get some money into retirement, a solo 401k is a great place to start. But make sure the plan at least allows for : (1) an elective profit-sharing component; (2) a Roth contribution; (3) rollovers from other plans; and (4) a loan provision. Clients don’t have to utilize all of these components, but at least they are options.

Since the client is only in the 15% tax bracket, they are not facing a huge IRS tax issue. At $100k a year in taxable income, they still can take tax credits for their children and are not faced with phase-outs like higher income earners. That is why the Roth 401k is a great option for him.

Assuming he and his wife can each generate enough earned income to contribute $18,000 each this will get them $36,000 annually. At 43 years old, let’s assume that he does this for 20 more years that is $720,000 and this does not consider any investment returns. At age 65 he and his wife should be able to take out upwards of $60,000 a year and not outlive their money.

Now $60,000 a year may not sound like enough for retirement. But when you consider it is tax-free then it makes a lot more sense. Combined this with social security and income generated from his rental properties he should be just fine.

Excess Roth Strategy

This one is one of my favorites that only some have heard of. The IRS probably it’s not a big fan either, but it’s allowable in the tax code.

Most people know that a contribution to a Roth IRA is subject to income limitations in the $200,000 range. So most high-income taxpayers can’t make your contribution and have to resort to the back door Roth solution.

But what happens if you overfund an IRA or a Roth IRA? Said differently, what if you contribute an amount to a Roth IRA where you never qualified in the first place?

In the IRA, the IRS taxes excess contributions at 6% of the excess amount. This might sound like a lot, but when it comes to penalties, this is lower than you think.

What happens if you contribute $100,000 to a Roth IRA in a given year? You can only contribute in excess if the excise penalty is factored in.

So let’s stick with the $100,000 example. Let’s say you can self-direct the Roth and earn 15% on the money. You would owe an excise tax at the end of the year of $6,000, but your Roth grew by $15,000. You have a net profit of $9,000. Not such a bad deal.

Because of the fixed penalty amount of 6%, investors using this strategy must ensure they’ve got a good chance of earning a rate substantially over the excise tax penalty. So there is some risk there. But if you’ve got a home run investment, this can make a lot of sense.

The excise penalty is calculated and reported on form 5329 on your personal tax return. Your CPA can fill this form out for you. But remember, it’s doubtful your CPA is aware of this strategy.

It is reflected on Part IV to form 5329 and you can see the section below:

Paul Sundin

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