COVID-19 left many people short on cash in 2020. Layoffs, furloughs and cut hours meant less income. As challenging and stressful as it is taking a pay cut, even a temporary one, there are some ways to use it to your advantage.
If you experienced an income loss steep enough to knock you down a tax bracket, this is a great opportunity to move some money to a Roth ira or use backdoor roth conversions.
What should you know about Roths and Backdoor Roth Conversions?
A Roth IRA has a few main tax benefits: tax-free growth, tax-free retirement withdrawals and no required minimum distributions (RMDs.)
(This is different from a traditional IRA, where you can contribute pre- or after-tax dollars, your money grows tax-deferred, and withdrawals are taxed as income after age 59½.)
One downside to a Roth IRA is the income limit. Your Modified Adjusted Gross Income (MAGI) has to be under $137,000 for the tax year 2019 to be eligible for a Roth. Even if your income is within that limit, you can still only contribute $6,000 a year.
There is a way around those limits, however: the backdoor Roth conversion. This allows you to bypass income and contribution limits by first contributing to an IRA, and then converting those funds to a Roth IRA. If you go this route, make sure you do your homework first or work with a financial advisor or CPA to make sure you follow all the IRS rules.
Who should contribute to a Roth in 2020?
So why would a loss of income be a perfect opportunity to contribute to a Roth?
If you’re at a lower income bracket in 2020, that means you can make contributions at a lower taxable income than next year, if you’re expecting your income to return to a higher bracket in 2021.
There are a few other situations where it makes sense to contribute to a Roth.
If you have assets tied up in pre-tax accounts like a 401k/403b or an IRA, moving money to a Roth can help balance your asset allocation.
Your age is also a factor, because the younger you are, the more time you have to allow your Roth funds to grow.
Finally, if your retirement income will come mostly from social security and a pension, your required minimum distributions need will be less. So this is another opportunity to grow and diversify your income in a Roth.
In-service and partial rollovers
If you have a 401(k) with your current employer, you can do what’s called an in-service rollover. All this means is that you’re asking your current 401(k) administrator to transfer some or all of your account to an IRA.
Check your summary plan descriptions for more information about in-service rollovers (some plans will call this an “in-service withdrawal.”)
It might also make sense to take just some of your 401(k) and move it to an IRA. This is called a partial rollover.
Whichever option you go with, the goal is to get some money into an IRA to take advantage of a lower tax bracket and boost retirement savings. (Just remember that any contributions must be made by Dec. 31, 2020 to count for this year.)
Do you need help planning for retirement? Contact me today to set up a meeting to talk about your goals. You can also download my free ebook for physicians for tips and information about getting your finances on track.