Tax Traps, Part 1

Talking taxes on a Friday is a lot easier than talking taxes on a Monday! Believe it or not, at this time of year it is smart to be talking taxes no matter what. Preparation and planning are the name of the game.*

The issue of higher FUTURE taxes is critical to clients of all income levels – especially those in higher tax brackets – and all ages. You will hear me repeatedly hammering home this “tax trap” issue – with the research and collaboration from my sources to back it up.

Here is some “good” news when it comes to taxes and tax strategies: the Roth IRA, Roth IRA conversion and Roth 401k are alive and well for now. The “good” part is that for nearly ALL reading this, you ARE eligible for both the Roth IRA conversion and the Roth 401k (if your company offers a Roth 401k) even if you are in the higher/highest income brackets or own a business! And these strategies can be employed NOW for 2020 and 2021.

These Roth strategies can make a BIG difference. How?

Roth 401k – not the same as Roth IRA

The popular misconception is that the Roth 401k is not available to high income earners. The correct information is that there is NO income limit to be eligible for the Roth 401k (if a Roth 401k is available from your company). If you make $30,000 annually, $300,000 or $3 million you are still eligible for the Roth 401k. The difference is that Traditional 401k salary deferrals (meaning contributions) are PRE-tax and Roth 401k salary deferrals are AFTER-tax.

Now you may ask, “Why would I want to give up my tax deduction by using the Roth 401k?” The reason is that – especially if you max out – you will likely have A LOT of monies saved someday in your (pre-tax) 401k. And if you have changed jobs a few times and have “Rollover IRAs” then those (pre-tax) monies have and will continue to accumulate. AND YOU WILL BE FORCED TO PAY TAXES LATER ON THE REQUIRED MINIMUM DISTRIBUTIONS (RMD’s).

On the other hand, when you use the Roth 401k – and make after-tax contributions today – you can roll those monies over to a Roth IRA later and HAVE NO RMD’s *AND* IF YOU DO USE THOSE MONIES THEY ARE TAX-FREE.

A strategy to partly preserve a deduction from your taxable income is to contribute partly to the Traditional 401k (and get the tax break today) and partly to the Roth 401k (and get the tax-free advantage later). Ask me about this.

Roth IRA Conversion

There is currently no income limit on doing what is called a Roth IRA Conversion. In this case, you “convert” monies today from your Traditional IRA or Rollover IRAs (both of which contain pre-tax monies) to Roth IRA monies. You pay ordinary income taxes on the converted monies and you will then have precious tax-free Roth IRA monies that can continue to grow tax free and have NO RMD’s. According to my reading on the topic, the reason that 2020 & 2021 could be good years to do the conversion is that the lower tax brackets of 22% and 24% (especially for newly retired people) are broad enough to encompass income between about $39,000 and $160,000 for Single taxpayers and between $79,000 and $321,000 for joint taxpayers. The brackets are set to increase slightly in future years to account for inflation. An important point is that this strategy is for those who believe their tax rates in retirement will be the same or higher than today (a somewhat safe bet).*

Roth IRA

The Roth IRA is still available only to those making less than about $124,000 for Single taxpayers and less than $196,000 for joint taxpayers. IF YOU ARE MAKING UNDER THOSE AMOUNTS, DEFINITELY CONSIDER THE ROTH IRA! The tax-free growth feature of the monies in the Roth IRA will help you in the long run. Ask me about the 5-year Roth IRA rule for an extra advantage.

Wait until we get to the subject of cuts to Social Security payments in future years due to pressure on the US Federal government’s Social Security Trust Fund. I tried to make it worthwhile even enjoyable – for you to read about taxes. Please let me know. I love hearing from my readers!

* CONSULT WITH YOUR TAX ADVISOR FOR ALL TAX ADVICE.