Portnoff Financial LLC- Blog

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March 2016

IRAs 401ks or both?

I  just answered a  question on www.Nerdwallet.com  which was "You can have a Traditional IRA and a Roth IRA; but can you also have a 401k and a Roth 401k, all 4 at the same time?" and thought I'd put this on my blog since it is a common question. Here is my answer:

Yes, you most certainly can have a Traditional IRA, a Roth IRA, a 401k, and a Roth 401k all at the same time. The issue will be which you can contribute to and how much.

For example, the annual contribution limit for IRAs is $5,500 plus $1,000 catch up (CU) if over 50. Let’s assume you are under 50 for my explanation. You can contribute any combination of amounts between a Traditional IRA and a Roth IRA as long as the total does not go over the limit, $5,500. So you could put $3,000 in your Traditional IRA and $3,500 in your Roth, or $1,000 in your Traditional IRA and $4,500 in your Roth.

Anyone can contribute to an IRA regardless of income but your ability to deduct it would be limited if your Adjusted Gross Income (AGI) is over $98,000-$118,000 if you file a joint tax return ($61,000-$71,000 Single/Head of Household) being that you are covered by an employer plan. If you make too much to make a deductible contribution then you might want to look to the Roth IRA however your ability to contribute to a Roth IRA is limited if your Modified AGI is $184,000 to $194,000 for joint filers ($$117,000 to $132,000 single/HOH). If you are over this amount then you would consider a non-deductible IRA and potentially convert it to a Roth (no income limit to convert) supposing you have no other IRA funds (if you do a pro-rata rule applies and may not be worthwhile).

The 401k contribution limit is $18,000 with a $6,000 catchup if you are over 50 (which I’ll assume you are not for purposes of this answer). Similar to the answer above on contributing to a Traditional IRA and a Roth IRA, you can contribute to both your 401k and your Roth 401k as long as the total does not go over $18,000. The amount you contribute to the 401k or Roth 401k has no impact on the amount you can contribute to an IRA (but does affect whether you can deduct it or not).

So if you have the money you can put $5,500 ($1,000 CU) to any combination of IRA and Roth IRA plus $18,000 ($6,000 CU) to any combination of 401k and Roth 401k for a total of $23,500 ($30,500 if over 50).

Now whether you should put more in the pre-tax versus the Roth (tax-free) is essentially a function of what your marginal tax bracket is now versus what you think it will be when you take the funds out. If you think you will be in a lower bracket in the future then pre-tax is the way to go, however if you think you will be in a higher bracket and/or you think tax rates are going up (due to terrible government debt) then Roth can be the way to go. If you’re not sure you can diversify to both which is not a bad idea. The pre-tax vs. Roth is really like any other investment except that you are betting on tax rates. One will be better than the other but you won’t know until the future arrives which is the same reason we diversify between stocks and bonds, between US and international and emerging markets, and Large cap and small cap, and growth and value, etc. 

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Dave Ramsey and the proposed Fiduciary rule by the Department of Labor

Dave Ramsey the financial author, radio host, television personality, and motivational speaker, recently  publicly criticized the proposed Fiduciary rule by the Department of Labor (DOL). Ramsey posted on Twitter “This Obama rule will kill the middle class and below['s] ability to access personal advice.”

To read the article from Investment News go to http://www.investmentnews.com/article/20160223/FREE/160229982/adviser-twitter-fight-erupts-when-dave-ramsey-bashes-dol-fiduciary.  

I think it is simply ridiculous to suggest that if all “financial advisors” were fiduciaries and required to act in the best interests of their clients and disclose all conflicts of interest that would somehow hurt middle class access to financial advice. While I am a fee-only advisor and prefer the model of full disclosure of compensation I do not think commissions are inherently bad. I don’t see anything wrong with selling financial products as long as all compensation, direct and indirect, are fully disclosed so that the client can make an informed decision. Therefore I see no reason why a commission based advisor could not put their clients interest first.

To suggest a fiduciary standard for all advisors would hurt access for middle class investors is like saying doctors who take the Hippocratic Oath (“…With regard to healing the sick, I will devise and order for them the best diet, according to my judgment and means; and I will take care that they suffer no hurt or damage…”) would reduce access to doctors by the middle class and the poor. Absolutely Not! This would be akin to doctors who do serve middle class and the poor not having to act in the best interests of their patients based on their judgement, etc. The idea is simply nonsense and I agree with (probably) most who have criticized Dave Ramsey in that those who are against this are so because they have a vested interest in not being required to put their clients’ interests first.

My view might be different in that I don’t think all “financial advisors” should be held to a fiduciary standard, rather that all advisors of any kind should be required to disclose all compensation, direct and indirect, as well as all conflicts of interest so that if the client wants to work with that broker/salesperson and buy their products they can at least make an informed decision. I personally might still choose to purchase a commission based product from a salesperson if they disclosed that they are not required to act in my best interest because I may feel that purchase is in my best interest and as long as I’m aware of that I can make a fully informed decision. For example if I go to buy a car the salesperson is not required to act in my best interest but as long as I have all the information I need (research on the car, truth in lending, etc) I can make a fully informed decision.

So I don’t think applying a fiduciary standard to all “advisors” will fix the problems in the industry nor do I think getting rid of all commission products will either. Rather if we had simple common sense regulations that require the full and clear disclosure on compensation, direct and indirect, as well as conflicts of interest in a manner that is understandable to the clients then we’d make some progress towards protecting the public and people could then choose who they want to work with.

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2015 IRA Contribution Reminder

It's not too late to make an IRA contribution for 2015. The deadline is the tax filing date which is Monday 4/18/2015 this year however generally it is not a good idea to wait until last minute.

Individual Retirement Accounts (IRA) are tax deferred, or in the case of a Roth IRA, tax-free savings/investment accounts. Tax deferral allows your money to grow faster without losing some of the growth annually to taxation. Having investments in an IRA also allow you greater investment flexibility to make changes without having to worry about generating any taxable capital gains transactions.

The IRA contribution limit for 2015 is $5,500 to any combination of IRAs and/or Roth IRAs as long as the total doesn't go above $5,500 unless you qualify for the catch-up contribution which is an additional $1,000 if you reached age 50 by year-end 2015.

Anyone is eligible to make an IRA contribution as long as you have earned income and you are under 70 1/2; whether you can take a deduction for a traditional IRA depends of a few factors described below. Eligibility to contribute to a Roth IRA depends on income which is also described below; there is no age limit to make Roth IRA contributions.

 

Phase-Out Range for IRA Deductibility: If you are considered an active participant in a company retirement plan, your deductibility for an IRA may be limited. If you are married filing jointly the phase-out for deductibility begins for adjusted gross income between $98,000- $118,000; above that there is no deduction. If you are a single or head of household filer the phase-out for deductibility begins for adjusted gross income between $61,000- $71,000; above that there is no deduction. If you are not covered by a company plan but your spouse is, the phase-out range for you is $183,000 - $193,000. If you file married-separate, your phase-out range is $0 - $10,000. If your income falls between the phase-out range, your ability to deduct your IRA contribution will be limited. There is a specific calculation to determine the amount you can deduct so if this applies to you, consult your tax advisor to determine how much you can deduct.

Even though you may not participate in the company plan, you may be considered an "active participant” so it is important to verify before attempting to take a deduction. If you and your spouse (if applicable) are not covered by a company plan, then there is no income limitation to take a deduction for an IRA contribution. SEP and SIMPLE IRAs are considered company plans for these purposes but are not included in the maximum contribution amount as they have their own limits.

Eligibility for Roth IRA Contribution: If you are married filing joint, the phase-out of eligibility to contribute to a Roth IRA is between $183,000 - $193,000 of adjusted gross income; above that you cannot make a Roth IRA contribution. For single or head of household filers, the phase-out for eligibility is $116,000- $131,000. If you file married-separate, your phase-out range is $0 - $10,000. As mentioned above, if your income falls between the phase-out range, then your ability to contribute to a Roth IRA is limited. If you are above, then you cannot contribute directly to a Roth IRA however you are still able to convert IRA funds to a Roth IRA which is discussed below.

Non-deductible IRAs: If you wish to make a deductible IRA contribution but make too much income to be eligible to take a deduction, consider a Roth IRA instead. If your income is above the threshold to make a Roth IRA contribution, you can still make a regular IRA contribution however that contribution will not be deductible. In such a case of a non-deductible IRA contribution, your money goes in after tax but still grows tax deferred and your contributions when withdrawn are not taxable however the interest/gains will be taxable upon withdrawal.

These non-deductible contributions create "basis” in your IRA which when withdrawn come out tax-free in a pro-rata distribution relative to the amount of pre-tax money in your IRA. For example, if you have $100,000 in your IRA, $10,000 of which is after-tax basis, your ratio would be 10%. If you then took a distribution/conversion of $25,000, $2,500 of that would be considered a return of your basis tax-free while the $7,500 would be taxable.

IRA to Roth Conversions: Since 2010 anyone regardless of income can convert an IRA to a Roth IRA. This means that you could make a non-deductible IRA contribution and convert it to a Roth thereby getting after-tax funds in a Roth IRA which is in essence the same as making a Roth IRA contribution. This strategy is referred to as the “Back Door Roth.” It only works if you do not have other IRA funds because if you do, the pro-rata rules described above would apply. It is unknown if this loophole will be closed by congress or if they will allow anyone regardless of income to make a Roth IRA contribution; only time will tell. For now it is still there and people who this applies to should consider taking advantage of this great tax planning opportunity.

Mega Backdoor Roth:  The “Mega Backdoor” Roth is similar to what is described above however it is related to employer plans. There are many rules and details to be aware of but the basic idea is this: if the employer plan allows for after-tax contributions, you can theoretically contribute after tax funds up to the maximum Defined Contribution plan limit which is $53,000 for 2015 and 2016 plus $6,000 catch up contribution if over 50. Then, if the plan allows, you can request a distribution of only the after-tax funds paid to you and then deposit to a Roth thereby completing a Roth conversion of after-tax funds which means getting a whole lot of money in a Roth IRA, far more than the statutory annual contribution limit which also is limited by income levels.

For example, suppose you are maxing out your 401k at $18,000 and your employer provides a $6,000 contribution for you. That means $24,000 has been contributed leaving an additional $29,000 that could be put in using after-tax funds ($35,000 if over 50). If you had the ability to, you could contribute that $29,000 from your paychecks and at some point then request a distribution of those after-tax funds and convert to your Roth IRA. That would mean getting $29,000 in a Roth IRA in one year! Well you might say, “I have bills to pay and can’t take that much out of my checks.” Well obviously if you don’t have the funds you can’t do this but suppose you do have $29,000 in a savings or taxable investment account. In that case you would increase your contributions to the plan and use your savings to pay the bills and essentially shifting those taxable savings/investments into tax-free Roth IRA accounts. That’s why this is called the “Mega” backdoor Roth. Certainly many details are left out but this is the basic idea. If you think this could apply to you be sure to give us a call to discuss.

2016 IRA Limits: For 2016, IRA contributions limits stay at $5,500 if under 50 with the additional $1,000 catch-up contribution if you reach age 50 by year end. The phase-outs for IRA deductibility and Roth IRA stayed mostly the same from 2015 with a few exceptions:

  • IRA deduction phase-out for active plan participants
    • Single $61,000-$71,000
    • Married filing jointly $98,000-$118,000
    • Married filing separately $0-$10,000
    • Spousal IRA $184,000-$194,000 (you are covered but your spouse is not)
  • Roth IRA phase-out
    • Single $117,000-$132,000
    • Married filing jointly $184,000-$194,000

If you have any questions about IRA contributions or wish to make an IRA contribution for 2015 give us a call.

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