Strategies to Navigate Roth Contribution Limits

Roth IRAs stand as a potent instrument for amassing after-tax retirement funds, fostering tax-deferred growth of investments, and procuring tax-exempt withdrawals during retirement. Nevertheless, the presence of contribution limits can pose challenges for certain investors, hindering their capacity to maximize their savings and harness a tax-exempt reservoir of retirement income.

In 2024, the maximum annual contribution to a Roth IRA is capped at $7,000 for individuals (or $8,000 for those aged 50 and above). Nonetheless, this maximum contribution threshold dwindles for individuals whose modified adjusted gross income (MAGI) exceeds $146,000 for single filers ($230,000 for married couples filing jointly). Furthermore, those with a MAGI amounting to $161,000 or higher ($240,000 for married couples filing jointly) are ineligible to make any Roth IRA contributions.

Likewise, Roth contributions made to an employer-sponsored retirement plan are subject to a $23,000 annual limit in 2024, complemented by an extra $7,500 allowance for catch-up contributions for individuals aged 50 or above.

Should you discover your post-tax savings constrained by these Roth contribution ceilings, a multitude of Roth and other tax-free growth strategies remains at your disposal to enable you to optimize your retirement savings. 

1. Explore the option of a Roth IRA via the backdoor method.

When your income surpasses the threshold for direct Roth IRA contributions, resorting to a “backdoor” Roth IRA strategy can prove to be a viable and effective alternative. This approach entails the creation of a traditional IRA in conjunction with your existing Roth IRA. You’re allowed to contribute the same annual limits of $7,000 ($8,000 for individuals aged 50 and above) to your traditional IRA on an after-tax basis. In other words, you forgo the deduction of taxes in the present year for your contributions to the IRA account. Subsequently, you execute a conversion, transferring the funds from the traditional IRA into the Roth IRA

Since there are no income constraints imposed on traditional IRA contributions when made on an after-tax basis, this strategy extends the opportunity for high-income individuals to contribute to a Roth IRA. This is permissible by the IRS.

However, there is a critical caveat to bear in mind with this approach. If you possess an existing traditional IRA containing pre-tax funds, you must execute the removal of the pre-tax dollars from the account before finalizing the backdoor Roth conversion. Failing to adhere to this requirement could render your conversion liable to tax obligations, contingent on the proportion of pre-tax to after-tax dollars in the traditional account, potentially resulting in double taxation. It is imperative to collaborate with a qualified professional before proceeding with a backdoor Roth IRA strategy to ensure compliance and maximize its benefits.

2. Consider a “mega” backdoor Roth.

This strategy elevates the backdoor Roth IRA concept to a higher plane, enabling individuals with incomes surpassing IRS limits to significantly enhance their after-tax retirement savings. This multifaceted strategy encompasses two key steps:

• Contribute after-tax funds to your employer-sponsored retirement plan, such as a 401(k).
• Execute an in-plan conversion of the after-tax assets, directing them into a Roth IRA or Roth 401(k).

For the year 2024, the IRS extends the privilege of contributing up to $69,000 in after-tax assets to an employer-sponsored retirement account. This contribution ceiling applies under the assumption that you are not eligible for an employer matching contribution. However, if you do receive an employer match, you must subtract any contributions made by your employer from the $43,500 limit to ascertain your maximum allowable contribution amount. Following this contribution, you have the option to directly convert these assets into a Roth IRA or Roth 401(k), thus serving to maximize your after-tax retirement savings. It’s imperative to maintain vigilance regarding IRS guidelines and consider consulting financial experts to ensure seamless implementation of this strategy.

It’s worth emphasizing that not all employer-sponsored retirement plans provide the flexibility for this kind of conversion. Moreover, the creation of a mega backdoor Roth account is a complex strategy with various intricacies. Given the multifaceted nature of this approach, it’s advisable to collaborate with a knowledgeable wealth advisor. Their expertise can prove invaluable in navigating the nuances of this strategy, mitigating potential missteps, and averting tax penalties.

3. Create a Spousal Roth IRA

For married individuals whose spouses do not generate earned income, the concept of a spousal Roth IRA can be an advantageous strategy to explore. This approach permits you to make contributions to a Roth IRA on behalf of your spouse, effectively doubling your aggregate retirement savings capacity. However, it is imperative to ensure that you satisfy the income criteria and comply with the contribution limits for both your personal account and your spouse’s. Careful attention to these requirements will help you maximize the benefits of this strategy and bolster your retirement savings as a couple.

4. Utilize the Benefits of Your Roth 401k

Although it doesn’t directly address the Roth IRA contribution limits, channeling your contributions into a Roth 401(k) can serve as a practical alternative for high-income individuals striving to accrue after-tax retirement savings. Diverging from Roth IRAs, Roth 401(k)s do not impose income restrictions. If your employer extends the option of a Roth 401(k), it can be a prudent strategy to maximize your contributions to harness the benefits of tax-deferred growth and tax-exempt withdrawals during your retirement years. This provides an effective means for high-income earners to optimize their retirement savings.

5. Invest Unused 529 Plan Assets into a Roth IRA for Your Child

The Secure Act 2.0, enacted in 2022, introduced a noteworthy provision enabling the conversion of unused 529 plan funds into Roth IRAs for a beneficiary without incurring tax obligations. To qualify, the 529 account must have been in existence for a minimum of 15 years, and the maximum lifetime amount that can be converted from the 529 plan to the beneficiary’s Roth IRA is capped at $35,000. Additionally, the annual amount that can be converted is subject to the same eligibility criteria as conventional Roth contributions. This approach can be a valuable means of initiating the retirement savings of a child who didn’t fully utilize their 529 plan and might face financial constraints in making retirement contributions as they commence their career.

It is paramount to recognize that the strategies outlined above involve a range of financial intricacies. Mishandling them could result in additional tax liabilities. Therefore, it is highly advisable to collaborate with a seasoned wealth advisor when implementing these strategies to safeguard your retirement savings and avoid costly mistakes.