Kelly Bullis
I fear writing articles for too narrow a group. This one is for self-employed folks. It is best if you think your tax bracket is going to be high after you retire, especially if you will be subject to large Required Minimum Distributions (RMDs).
Everybody has heard of a Roth IRA, but have your heard of a Roth 401(k)?
The contribution limits of a Roth IRA are the same as a regular IRA – $7,000 (or $8,000 if you’re over 50). BUT, if your income is too high (MAGI higher than $240,000 for marrieds), you can’t even make any contributions to a Roth IRA (at least the normal way).
A Roth 401(k) allows you to make annual contributions at the same levels as a regular 401(k) – $23,000 (or $30,500 if you’re over 50). And best of all, there are no income limits on making contributions.
You heard me right. You could make $1 million and still be able to contribute to a Roth 401(k). Oh boy! I hear the wheels turning now. “If I can’t make any contributions to a Roth IRA, then why don’t I open a Roth 401(k)?” Remember? You have to be self-employed in order to open a Roth 401(k). If you are just pulling a salary from some non-owned employer, you can’t open a Roth 401(k).
Roth accounts, just like regular IRA and retirement accounts grow tax-free. The real nice feature of Roth accounts is that when you take out distributions (when you are eligible), they are tax free.
The downside of a Roth type account, the contributions are not tax deductible. You put after-tax money in. (Can anybody think of the name of a government program that is just like the Roth? You put in after-tax money and then take out distributions when you retire, only those distributions will most likely be taxable? SOCIAL SECURITY. I would love to see the government make Social Security back into what it was originally created to be: not taxable.)
You can also do a ROTH 401(k) conversion, just like a ROTH IRA conversion. Same process, whatever amount you convert is fully taxable in the year you convert.
Here is a real-world scenario. A 40-year-old has $200,000 in her 401(k) account. By the time she turns 65, the account would have grown to $1 million. If she did a Roth conversion when it was only $200,000, her tax might come to about $56,000. If she didn’t convert and waited to start taking funds out at 65, if she did a Roth conversion at that time, she would pay about $370,000 in tax. (And that’s assuming tax rates don’t go up when she is 65.)
There was a catch until recently. You had to take Required Minimum Distributions (RMDs) on Roth 401(k) accounts, just like regular IRA and other retirement accounts. Recent legislation has changed that so that starting in 2024, Roth 401(k) accounts are now the same as Roth IRA accounts. That being, you do NOT have to take out RMDs.
Have you heard? Psalms 92:14 says, “They will still produce fruit in old age. They will be full of sap and green.”
Kelly Bullis is a Certified Public Accountant in Carson City. Contact him at 775-882-4459. On the web at BullisAndCo.com. Also on Facebook.