In this episode of Thimbleberry U, Jag and Amy Walls from Thimbleberry Financial delve into the intricacies of Roth accounts for high-income earners. Amy begins by explaining the basics of Roth IRAs and their appeal to high-income individuals, particularly due to their tax-free growth and distributions. She emphasizes the importance of Roth accounts in the current low-tax environment and their role in portfolio diversification.
The conversation then shifts to who can benefit from Roth accounts. While lower income brackets are often considered ideal candidates, high-income earners also stand to gain significantly, provided they approach it strategically. She outlines the income limits for Roth IRA contributions, highlighting the differences for single and married filers and the additional contributions allowed for those over 50.
Amy and Jag discuss the SECURE Act 2.0 and its implications for Roth accounts, including the new provision allowing employer matches in 401ks and 403bs to be directed towards Roth accounts, and the delayed implementation of a rule mandating catch-up contributions to be made to Roth accounts, starting in 2026.
The conversation then explores various strategies for high-income earners to maximize their Roth contributions, such as backdoor Roth conversions and after-tax contributions to employer plans. Amy stresses the complexity of these strategies and the importance of understanding their tax implications.
Regarding optimizing Roth investments, Amy advises high-income earners to consider aggressive (but within their risk tolerance) investment strategies within their Roth accounts due to their tax-free nature. She also touches on the importance of regular portfolio reviews and being mindful of tax-efficient investing.
Finally, there are limitations and pitfalls of using Roth accounts, such as income phase-out limits and tax consequences of improper conversions. Amy emphasizes the need for careful planning and awareness of contribution limits and deadlines. We also highlight the tax planning benefits of Roth accounts, including their role in estate planning and the flexibility they offer in managing future tax brackets.
Jag: Welcome back to Thimbleberry U. I am Jag “Jag” Gay with Amy Walls from Thimbleberry Financial. Good to be back with you, Amy.
Amy: Good to be talking to you today, too.
Jag: We talked a lot about Roth accounts in prior episodes, Amy. Today, we're focusing on them for high-income earners. Can you give us, to start, a brief overview of Roth accounts and why they're valuable for high-income earners?
Amy: Absolutely. Roth IRAs are Individual Retirement Accounts that when you put the money in, it grows tax-free and then is distributed tax-free in retirement. The whole idea of a Roth is about that tax-free income. You're putting in after-tax dollars. It grows tax-free. It's distributed tax-free. You can have these in a 401k or a 403b, too, as long as an employer has said, "Yes, we're happy to add this. We've added that provision." It's a way to not just contribute to the Roth IRA, which often doesn't work for a high-income earner, but still be able to get some money tax-free in retirement. We think about the value for high-income earners. It's tax-free withdrawals in retirement, which shields those earners from potential future tax hikes.
Jag: True.
Amy: Right now, with our current tax bill that sunsets at the end of 2025, we have very low tax brackets. It also gives a way for additional portfolio diversification. with that tax-free outcome. Depending on how you do it, because there's a lot of different ways to get money into Roth accounts, and I'm being general with the accounts portion. There's a lot of flexibility, which allows for greater control over income later on. It's that income later on and that flexibility that can be so important.
Jag: For sure.
Amy: So valuable.
Jag: You talked about the flexibility and income, and then also diversification between taxable and tax-free income sources. Amy, who can benefit from Roth accounts considering their income level?
Amy: People in lower income brackets are often assumed to be the best candidates for Roths. I don't disagree with that, but they're not the only candidates. That's where I think there sometimes is a line that gets drawn. For high-income earners, they can also be good candidates when the whole picture is looked at and the approach is done carefully.
Jag: Got it. How can high-income earners maximize their contributions to Roth accounts?
Amy: Yes, Jag, you mentioned contributions. Let me get some information out here. Today's focus is on high-income earners. I said something about Roth IRAs and that those typically aren't something a high-income earner can contribute to. The reason for that is their income ranges for contributions to a Roth IRA. For someone who's single, to make a full contribution, their income needs to be under $146,000. Then there's a phase-out range by the time their income, this is MAGI, gets to $161,000, they can't contribute anything. For someone who's married, filing jointly, that income range is $230,000. Under $230,000, you can contribute the full amount. Then at $240,000, you can't contribute anything.
Jag: Got it.
Amy: In between. It's varied in terms of the amount someone can contribute. In 2024, if they're under age 50 throughout the year, it's $7,000. If they're 50 or older, it's $8,000 for 2024.
Jag: Just to clarify, because I know it used to be $6,000. That's for the 2024 tax year, not right now, looking back at 2023.
Amy: Correct. A great clarification. When we're talking about high-income earners, it may be possible with contributions into 401ks and 403bs to get income low enough that somebody could contribute to a Roth IRA directly. More than likely, the opportunities are going to come from using 401ks and 403bs through direct contributions. Maybe that is taking 10% of salary. Instead of having it go pre-tax, it's having it go to the Roth side. Now, many high-income earners are going to want to lower their taxes today so that may not work. This is a key change that has happened. Now, if they're Roth provisions, the SECURE Act, which went into effect January 1, 2023, allows employer matches in a 401k or 403b to be put towards the Roth side of those accounts rather than have them go pre-tax. Pre-tax has been the only option, and that is no longer the case. Pre-tax is the default, and employers have to say they will do this. In 2023, I didn't see employers ready to put that in place. Now that we're rolling into 2024, that should be more available.
Jag: You said that changed with the SECURE Act 2.0, the second version that was recently passed in Congress.
Amy: Correct. There's one other thing that I think our listeners should be aware of on this. This was actually supposed to go into effect January 1, 2024, but it has been delayed to 2026: Earlier I talked about those contribution differences when you're under 50 and over 50. That's in an IRA. The same thing exists in a 401k or 403b. What is changing come January 1, 2026, is all catch-up contributions from an employee will automatically go to the Roth side of these accounts. You will no longer be able to make catch-up contributions pre-tax.
Jag: That's interesting.
Amy: Other ways that somebody can get money into Roth accounts, contributing to a traditional IRA and then converting that to a Roth. Now there's lots of tricks to doing this properly from a tax standpoint. This is called a backdoor Roth, and we've talked about it in former episodes. I'm hoping no listeners take what I just said of, "I can put money to a traditional IRA and convert." You'll likely run into problems. It's more complicated than that, but it is one way of doing it.
Jag: Lots of T's to be crossed and I's to be dotted before you just go ahead and do that. Refer to our previous episodes or talk to a professional. Got it.
Amy: Yes. After-tax contributions to an employer plan that then are converted, much the same as what I just talked about. It's just on a bigger scale. Spousal contributions, perhaps. Perhaps one spouse stays home or has a lower income, doesn't have a retirement plan. They might be able to contribute directly to a Roth. Then conversions.
Jag: Sure.
Amy: Conversions of IRA money to Roth.
Jag: Got it. I know you deal with a lot of high-income earners in your practice at Thimbleberry. What are some of these advanced tricks for high-income earners to contribute to Roth accounts?
Amy: Some of them I just touched on briefly. The backdoor Roth conversion, which is when you make an IRA contribution and convert that money to a Roth. This can be done regardless of income. Those tips and tricks that we alluded to, some of them, you don't want to have an IRA balance to make this work. There are special tax forms that need to be filled out, notating that you've made a non-deductible contribution. That's a strategy a lot of our clients use and that we help them with. Also, then doing that on the bigger scale, that mega backdoor Roth, which is making after-tax contributions to a 401k or a 403b. Then within the plan, converting those to Roth. There's a lot of opportunity there. Again, a lot of our higher-income clients, we have doing that. One that we have not touched on is Roth conversions in retirement. I mentioned conversions are an option. For many of our high-income earners that right now, while they are working, when we just aren't finding a way to get money into a Roth, based on their overall situation, it might be that in the first few years of retirement, especially if they're retiring earlier, and many of them are, it's a prime time because of how their assets are arranged for them to do some Roth conversions, either in small or big amounts, depending on the situation. It really sets them up for flexibility in the future and reduce tax bills for a longer period of time.
Jag: We've talked about getting the money into these Roth accounts. How can high-income earners optimize the Roth investments once the money's there?
Amy: First, it's asset allocation. One of the things to think about with a Roth account, the money is tax-free. If you could have money growing at different rates, and this goes back to our very first podcast, where we talked about tax diversification, depending on what the taxation will be in the end, can help dictate how long you might want to keep that money invested, as well as how you would want that money to grow. For example, since Roth is tax-free, there's no reason not to give it all the firepower, if you will. One of the analogies I like, even though I'm not a race car fanatic, is that Roths are like a race car. It's not like your scooter, and it's not like the family sedan. It's the race car. You want it to have the special tires. You want it to have the special oil, all of this maintenance going into it. You want it to have power.
Roths are the same way because it's growing tax-free. It's being distributed tax-free. With that said, even if your risk tolerance is not aggressive, you may want your Roth money to be your most aggressive investment.
Jag: Ah, okay.
Amy: That doesn't mean they are aggressive, but that they are your most aggressive because if you can get that growth and it's distributed tax-free, you've won.
Jag: Yes, I like that.
Amy: You've paid less in taxes and got to keep more.
Jag: I like that analogy because everything is relative in terms of your risk tolerance, but you're saying within your individual portfolio, whether you're risk-averse or risky or aggressive or conservative, within your parameters, you want the Roth money to be the most aggressive of everything you have.
Amy: You may. I'm not saying for sure you would. In many cases, that can make sense so that you take advantage of that tax-free growth and distribution. That also means this is probably the last money, if that's the framework and plan you have, the last money you want to use in your life.
So that it has more time to grow tax-free and be distributed tax-free.
Jag: Got it.
Amy: Another thing that high-income earners can think about with Roth is, a lot of times they're worried about tax-efficient investing. Because if they're saving money in a place that it's taxable, that's on their minds. They've learned, "I get hit with this tax bill regularly." In a Roth account, we don't have to worry about that because there aren't taxes, as long as we follow our distribution rules. Then another thing to do in optimizing is just regular portfolio reviews.
Jag: Oh, yes.
Amy: Which monitors this. I can't tell you how many times we've had new clients come to us and I find their Roth IRAs in cash or are being their least aggressive dollars. It's just backwards from what often makes the most sense.
Jag: We've alluded to this throughout the podcast, but at a high level, what are some limitations and pitfalls to watch out for as a high-income earner using a Roth account?
Amy: First, I'm going to go back to those phase-out limits we talked about earlier. It's really important to know those numbers because someone might think they're going to reach it and be able to contribute and then not. Knowing your income, sometimes at the beginning of the year, it looks like, "Hey, this is going to be my income. If I contribute to my 401k, I'm going to get under this amount." Then a raise comes through and shoots you right over the top. Then you've got money in a place you can't have money. Being really aware and what changes. I always tell people, if we think you're on the border of this, let's wait and make a contribution at the end of the year or even the beginning of the following year.
Jag: Got it.
Amy: Another pitfall is the tax implications of the conversions. We touched on these conversions earlier. If they're not done right, in terms of the back door where you've made a non-deductible or after-tax contribution, there will be tax consequences. The goal is to have them be tax-free. If you're just doing regular conversions, it creates a tax bill. What does that do for people in retirement? If they're 65 or going to be 65 two years down the road, that can affect Medicare prices.
Jag: Oh, for sure.
Amy: We need to be aware of that. Then just watching for contribution limits. Obviously, I talked about age, but if you do make a mistake and you contribute to a Roth and you shouldn't have, you have to get it corrected by October 15th of the next year. 2023 has to be corrected by October 15th, 2024. Then last, not filing that form 8606 I referenced earlier.
Jag: Got it. How can high-income earners, Amy, balance Roth accounts with those other retirement savings options?
Amy: First, Jag, it comes down to tax diversification and looking at how much money you need to have in each area. What I mean by that is pre-tax accounts like 401ks, how much money in brokerage accounts where as it grows or as it's distributed, it's taxed as capital gains. Then how much money in Roth? Each person's situation is different and when they're going to need different buckets of money and how the taxes are going to play a role based on what their expected expenses are. Having a plan and knowing how you can enhance that plan with the different kinds of money if you're still working on saving. That also involves having a smart place to get at money. I've seen situations where someone said, "Hey, Roth's going to make sense. My life's going to be easier in retirement if I just have 100% Roth money and successfully do it." They've paid extra in taxes more than they probably needed to. They've potentially also kept themselves from having as much flexibility today as they might like.
Jag: All right, duly noted. Final question for you. What are the tax planning benefits of Roth accounts for high-income earners?
Amy: From a benefit standpoint, having Roth money allows someone the flexibility to manage tax brackets not only today but in the future. Like I said, the current tax bill has us paying less in taxes than what we have previously. It may not be sustainable. Having some choice as things change, which those changes are not within our control, can be really valuable for recreating a paycheck later on. Then I'd also say estate planning considerations. We've seen a number of our higher-income earners in retirement be concerned about how taxes are going to affect their children when they pass money on.
Roths allow that the kids will inherit that money in Roth accounts without paying taxes on it. That can be a huge benefit to some parents who want to set their kids up for success and whose kids may be high-income earners now.
Jag: Very true. Amy, there's a lot to this. As we've talked about, there are a lot of advantages. There are a lot of ways you can put this money to work as a high-income earner. As you mentioned several times, there are pitfalls to it too. It's so important that you do this exactly right for your individual situation. If somebody wants to come talk to you and your team at Thimbleberry Financial about this or anything else related to their finances, how do they best find you?
Amy: They can find us online at thimbleberryfinancial.com or by giving us a call at 503-610-6510.
Jag: Important and great stuff as always, Amy. We'll talk again soon.
Amy:
Sounds great, Jag. Look forward to it.