Blog Layout

The Roth IRA: A Key Ingredient to Your Tax—and Retirement—Strategy

Echo Huang • Nov 10, 2020

2020 is coming to a close. As you look back at what this year has brought, chances are, many other things topped your priority list before “tax strategy.” In a recent blog, I discussed tax strategies you should review  before year-end. Today, I’d like to spend a little bit of time going a bit deeper into one of those strategies…Roth IRAs and 401(k)s.


As a refresher, a Roth IRA allows you to save after-tax dollars, and withdrawals including earnings from the account (after age 59 ½) are income tax-free. The Roth IRA allows you to pay taxes now at a certain rate instead of paying taxes later at an uncertain rate. This is a great way to hedge against future income tax increases.


Let’s explore a Roth IRA a little deeper.


What Makes Roth IRAs So Special?


Here are a few rules that make Roth IRAs special: 

  • You can make contributions at any age.
  • You are not required to make a “required minimum distribution” (RMD) from a Roth IRA. (Traditional IRA account owners must start taking distributions at age 72, changed from 70.5 starting in the year 2020).
  • A non-working spouse can open a Roth IRA based on the working spouse’s earnings if they file tax returns jointly.
  • You can still make your annual contributions if you convert money from a traditional IRA to a Roth IRA in the same year. 
  • You can contribute to a Roth IRA even if you participate in a retirement plan through your employer. 


When it’s time to withdraw, you’ll pay the ordinary tax rate (typically higher than the long-term capital gain rate) on the distributions from the tax-deferred bucket (traditional IRA or 401(k) plan). You won’t need to pay any taxes on distributions from your Roth IRA after age 59 ½ or having met the five-year rule after converting some IRA money to Roth IRA. Because you use after-tax dollars to fund a Roth IRA, any distributions after age 59.5, including earnings, will be tax-free.


Can I qualify to contribute to a Roth IRA based on my income? The IRS determines the income limit each year for making contributions to a Roth IRA. If you are single, you must have a modified adjusted gross income (MAGI) under $139,000 to contribute to a Roth IRA for the 2020 tax year, but contributions are reduced starting at $124,000. If you are married filing jointly, your MAGI must be less than $206,000, with reductions beginning at $196,000. For 2021, the numbers are higher. The modified adjusted gross income for singles must be under $140,000; contributions are reduced, starting at $125,000. For married filing jointly, the MAGI is less than $208,000, with phase-out starting at $198,000. 


What If Your Income Is Too High?


How do you start creating the three buckets of money (tax-deferred, tax-free, and taxable) I spoke about in my last blog, especially in your 40s and 50s when your earned income is too high to contribute to a Roth IRA? You can consider a “Backdoor Roth IRA.” Here’s how it works:

My client, “David,” is age 51 in 2020, his MAGI is $300,000, and he’s married, filing jointly. He is planning to maximize contributions to his 401(k) plan at work that is $19,500 plus $6,500 catch-up contributions for people age 50 and over in 2020. He can still contribute to his traditional IRA account up to $7,000 ($6,000 plus $1,000 catch-up contribution) because he has earned income. 


The IRS has income limits to calculate how much of the contributions to an IRA are tax deductible and whether he is covered by a retirement plan at work. As his MAGI is over $124,000 and he is covered by a retirement plan at work, he cannot deduct any of his IRA contributions on his tax returns. However, the non-deductible contributions must be reported on Form 8606 when his federal income tax return is filed so that the IRS has a record of the cost basis of this IRA.


When he decides to convert this IRA balance to a Roth IRA in future years, he only pays income taxes on the earnings portion of this distribution in the year of the Roth conversion. If he does not have pre-tax dollars in this IRA, the taxes he will pay are minimal, and he creates a large Roth IRA over time. Therefore, do not forget to report contributions on your tax returns. As you convert any IRA balance to a Roth IRA, you’ll receive a tax form 1099-R that shows the distribution amount from your IRA, which must be reported on your tax return Form 1040. 


Other Roth Strategies


Converting from an IRA to a Roth IRA: In a year (or a few years) in which their income is lower than usual, retirees should consider converting a small amount of their IRA to a Roth IRA each year by watching out not to get into the next tax bracket. 


For example, looking at the 2020 federal tax rates, your next tax rate is 24% at $170,051 taxable income as a married joint filer, and your current projected taxable income for this year is about $135,000 (at a tax rate of 22%) because you just retired and decided to delay collecting social security benefits until age 70. Now you can convert an additional $35,050 IRA balance to a Roth IRA by paying taxes at a 22% rate. This way, you can increase your tax-free bucket without paying a high-income tax rate, which will help you keep taxable income low as you withdraw from your Roth IRA when your social security benefit starts at age 70.


If you started a new business and have reduced taxable income in the first year or two, it’s a good opportunity to consider converting some of your IRA to a Roth IRA by watching out for your next tax rate. I’ve converted a significant amount of my IRA balance to a Roth IRA myself twice over the past 16 years to dramatically increase my Roth IRA balance. As you must pay income taxes on the Roth conversion, it’s essential to start saving some extra money early in a non-retirement account. Invest less aggressively than your Roth IRA so that you can tap into it to pay for taxes on the Roth conversions. 


Saving even more: If you can save more and have a sizable non-retirement account already, you can also consider switching from contributions from your 401(k) to a Roth 401(k) as well (if your employer offers Roth 401(k)). The annual maximum is the same, but you essentially have increased your retirement savings by funding it with after-tax dollars and distributions that will be tax-free after age 59½. As I mentioned earlier, paying taxes now at a certain rate instead of paying taxes later at an uncertain rate is a way to hedge against future income tax increase through tax diversification. 


Use financial planning tools to project your future tax rates based on your projected taxable income year by year to age 95, and today’s tax laws will help you make smart decisions. Remember that you can contribute some to the traditional 401(k) plan and some to the Roth 401(k) plan as long as the total does not exceed the IRS maximum per year. In addition, your employer’s matching contributions will be taxable to you upon distributions.


To truly maximize your tax strategies, I recommend you consult with a financial advisor who is able to look at your overall financial picture and guide you along the way. If you are concerned that there’s just too much to know, I invite you to schedule a complimentary 30-minute Discovery Call. My team at Echo Wealth Management and I can help you navigate these waters. Wealth management can be complicated, but it doesn’t have to be. Let’s chat and see how we can be of service to you.

By Fang Huang 03 Dec, 2022
How important is long-term care? It is important enough for you to plan it. It is important enough for you to do it. It is important enough for you to think twice. That is why we observe National Long-term Care "Planning" Month in October, followed by National Long-term Care "Awareness" Month in November. The double reminder tells us that long-term care is critical in creating a healthy financial picture. It can be a meaningful gift that enhances peace of mind to the very end for you and your loved ones. In the previous article, we discussed the following: How long-term care is not as scary as you think Long-term care as part of your wealth management plan Why plan early for long-term care Let's now expand the long-term care conversation to explore the most common questions people ask to help you gain clarity on the next steps. What is long-term care, and why is it important? Long-term care involves various services designed to meet a person's health or personal care needs during a short or long period. These services help you live as independently and safely as possible when you can no longer perform everyday activities independently. What are the three basic levels of long-term care? Care is usually provided in three main stages: independent living, assisted living, and skilled nursing. Nursing homes offer care at home or in the community. Nursing homes provide skilled nursing care, rehabilitation services, meals, activities, help with daily living, and supervision. What is the monthly cost of long-term care? According to Genworth's year 2021 data, monthly median costs for Minneapolis Area are $11,708 for a semi-private room in a nursing home facility. Homemaker services: $7,055. How long do most people live in long-term care? According to the latest AOA research, the average woman needs long-term care services for 3.7 years, and the average man for 2.2 years. What are the significant trends in long-term care? An AARP survey revealed that 90% of adults over 65 would prefer to remain in their homes as long as possible. This statistic should be significant to long-term care facilities because they must consider including in-home health care to meet changing consumer preferences. What is commonly offered at long-term care facilities? These services typically include nursing care, 24-hour supervision, three meals daily, and assistance with everyday activities. Rehabilitation services, such as physical, occupational, and speech therapy, are available. Remember that you might stay at a nursing home for a short time after being in the hospital. Why is long-term care growing? An aging population and the increasing prevalence of chronic conditions will drive up demand for long-term care services, including assistance with the activities of daily life. What is the purpose of a long-term care policy? Owning a long-term care insurance policy aims to help you maintain your lifestyle as you age. Medicare, Medicare supplement insurance, and the health insurance you may have at work usually won't pay for long-term care. Thank you for exploring this important topic with us. For a complimentary long-term care plan review, schedule a time with an Echo Wealth Management team member. Together, let's identify possible action items to help you deliver continued peace of mind for your family.
By Fang Huang 28 Sep, 2022
According to LIMRA's 2022 Insurance Barometer Study, the secret to financial security is owning life insurance. Choosing the right products can help you to better protect your family’s lifestyle today and into the future. No matter what your age or situation is, owning a life insurance policy is an excellent family protection strategy. It allows you to leave an inheritance without your beneficiaries having to pay income tax on the death benefit they receive. Your beneficiaries could use the death benefit to replace your lost earned income and pay for essential expenses such as food, shelter, credit card bills, funeral or cremation costs, student and auto loans, medical bills not covered by health insurance, and so much more. It can also be used to provide extra support for retirement and the unexpected such as injury or illness. Whether you’re single, retired, or in any stage, life insurance can be a critical tool in a comprehensive financial plan. As a general rule of thumb, it’s an excellent idea to review your life insurance needs with a licensed financial professional every year to see where you stand regarding adequate coverage - should benefit increase or additional policies be necessary. Let’s explore how your life insurance needs may change according to the three primary stages of work and life. 1. Primary years (single and early career) Life insurance is often overlooked in the career establishment years, especially if you do not have a spouse or children who financially depend on you. The first step is to check with your employer and explore their benefits. Still, employer-sponsored policies typically offer coverage about 1-2 times your annual salary, which is a fraction of the coverage you may need. In addition, group life insurance coverage typically does not carry over with a job change. A good decision would be to purchase an individual or private life insurance policy outside of the workplace to supplement their coverage through work, especially if you have student loans or debt with a co-signer, support aging parents, or don’t wish to leave final expenses to family. Getting an early start on life insurance is smart as rates are typically much more affordable when you’re young and healthy. Generally, level-term life insurance (20 to 30 years) works well for people who plan to have children in the future. Level-term life insurance means the premium does not change during 20 or 30 years, unlike the group term policy through work. For example, it can cost $250,000 to raise a child, and you have a student loan balance and a mortgage, paying less than $500 per year could potentially have $1 million coverage when you are under age 30 and healthy. 2. Growth years (married with children and mid-career) At this stage, the need for life insurance coverage typically increases with your growing family and career advancement, so be wise in how you structure your policies. Consider the coverage you need to replace future lost earned income and any large debts that would burden your loved ones. In addition, factor in the cost of raising your children through college and add emergency savings for economic and lifestyle disruptions. Employer-sponsored life insurance benefits are typically not enough for your dual-income and household expenses, so consider increasing the benefits on your existing policy and purchasing life insurance for your spouse and children are great ways to help with maintaining adequate coverage for the entire family. Suppose your income is high and you have maximized contributions to all retirement plans. In that case, you can consider buying a permanent life insurance policy that has cash value and will pay the death benefits regardless of how long you live. The cash value can be invested, and the earnings are not taxed each year which helps you pay for the cost of insurance. 3. Empty nest (estate/retirement planning and late-career) In your final working years, you may have set aside a good bit of savings for retirement, but planning for your financial future doesn’t stop here. As you get older, you could tap into the cash value from your life insurance policy to help supplement your retirement income and may avoid paying income taxes on the earnings if you choose to borrow from the cash value. The unpaid loan balance will reduce the death benefit, which is all right as your beneficiaries may not need as much death benefit when you are retired and much older. The primary purpose of life insurance changes from income replacement to wealth transfer when you have accumulated enough assets to retire. If your estate is over $3 million, including the death benefit of your life insurance policies, consider advanced estate planning to reduce potential estate taxes. For Minnesotans, the estate exemption is $3 million per person for 2022, which means you may need to pay 13% to 16% Minnesota estate tax on the amount that exceeds $3 million. Federal estate exemption is $12.06 million for 2022, but it may be cut in half after the year 2024. The amount above the estate exemption amount is subject to a 40% federal estate tax. If you would like to minimize the shrinkage of your nest egg, using proper life insurance can be a solid strategy to address estate tax exposure. Setting up an irrevocable life insurance trust (ILIT) to own your existing permanent life insurance policies or buy a new one can remove the death benefit from your estate. In addition, you can gift annually to the trust to pay for the insurance premiums over time to further reduce your estate. Take advantage of an annual gift exclusion of $16,000 for 2022 and $17,000 for 2023 to fund the ILIT. You may not need to use much of your lifetime gift exemption as you file your gift tax return (Form 709). The ILIT with Crummey power gifts remains one of the most powerful estate planning tools for high-net-worth individuals. Done properly, you avoid entirely gift tax, estate tax, and income tax on your legacy to future generations. For business owners with most of their net worth in their business, liquidity is an issue as the estate taxes are due nine months from the day of death. To preserve the business for the next generation and to avoid selling stock portfolios during market decline to pay estate taxes, consider using life insurance to provide the money to pay estate taxes efficiently. Life insurance policies and tax laws are complicated, and they keep changing. I recommend you work with your trusted advisor who can help you assemble a financial dream team, including an estate attorney, a tax CPA, and a life insurance agent to give you customized recommendations and help you implement the strategies. Whether you have general or specific questions about life insurance, you can schedule a meeting with an Echo Wealth Management team member at any time. We'll be happy to answer your concerns and help you to find the right policies to achieve adequate coverage at every stage of your life.
By Fang Huang 31 May, 2022
You might be thinking… Other people get disabled, not me. My business can run without me. I’d rather put my money into growing my business. The truth is illness and injury impact all of us, even businesses. Whether you are a key employee or business owner, understanding the possible outcomes of a temporary or permanent disability will help you to identify smart solutions for your financial plan. Let’s look at each situation and its solution. 1. As a high-income earner, having both a workplace policy (group long-term disability insurance) and a private policy (individual disability insurance) helps to ensure that you will have adequate income protection for everyday living expenses like mortgage, utilities, and groceries. 2. Suffering a disability does not mean that you must stop contributing to your retirement account. Having a disability retirement security policy helps you to make that dream a reality; it pays benefits to a trust to be accessed as retirement income. 3. The worst thing that can happen to a business owner is when s/he can no longer keep the business open. Having overhead expense insurance helps you to pay for necessary expenses like employee salaries, accounting fees, and office rent. The key benefit here is that you can either return to your financially sound business or sell the business that has not depreciated because of your disability. 4. As a business owner, it’s crucial that you have a funding solution for your business should you or another owner become too sick or hurt to work. Disability buy-out insurance funds a buy-sell agreement helping to buy-out the disabled owner’s interest in the event of a long-term disability. Benefits are typically tax-free, and the disabled owner is taxed only on the gain from the sale of the business. If you are the main income earner in your family, even if you have group long-term disability insurance, it may not be enough to pay your basic living expenses as the benefits are taxable if your employer pays the premiums. You can consider buying an individual disability insurance policy that can supplement your current group coverage. Individual policies are not tied to employment that offers more flexibility as you may decide to change your job. Some policies can have an automatic increase in benefits feature based on your earned income without going through underwriting. According to the Centers for Disease Control and Prevention, one out of four adults in the U.S. will suffer some type of disability. You work hard for your family and/or business, so make protecting your income a priority. Remember that a disability is more than just an accident. It can happen to anyone, anywhere, anytime. To get started on a complimentary disability plan review, get in touch with me today and together, let’s take the necessary steps to protect the financial future of your loved ones, business, and/or key employees.
By Fang Huang 23 Feb, 2022
Sometimes, the unknown can be a bit scary. Previously, I’ve shared several financial tips that will allow you to plan for your financial independence and to own your future. Today, I want to ask you to give me a few somber minutes of your time. I am asking you to turn off your emotions and turn on your intellect only. This way, you will be protected from your emotions entering in and shutting you off from discussing a tough but important topic: Long-Term Care. Come out from under the blanket for a few moments to learn about this important element of financial planning. Let’s look at what it is, and I promise you, it’s not as scary as you might think. Long-Term Care as Part of Your Wealth Management Plan Yes, long-term care is just as important in your wealth management plan as is saving for your children’s education. Maybe I could make it easier for you to consider if I asked you to look at long-term care as a protection for your children/loved ones in lessening their burden when caring for you. When her fifty-year-old husband suffered a fatal stroke, “Lily” came to me to figure out what financial decisions she needed to make for her and her daughter in case she ever needed long-term care. Neither she nor her husband had a long-term care policy because they assumed they wouldn’t need it until they were in their seventies or eighties. Like most people their age, they thought they had more time to think about it. Another reason people don’t think about long-term care is the same reason they often don’t want to think about estate planning - they don’t want to dwell on their own disability. No one wants to think about being incapacitated and not being about to perform the six activities of daily living: eating, dressing, bathing, toileting, transferring, and continence. Unfortunately, the reality is that many of us have to face this situation at some point in our lives. Too many people make the mistake of waiting too long to take out a policy to protect them from this eventuality. Why Plan Early? More than a decade ago, Congress passed a law to encourage more people, especially baby boomers, to plan early by buying long-term care insurance. Special tax benefits were offered to motivate people to plan ahead so that they didn’t end up on government assistance, either Medicare or Medicaid. The government’s attempt to incentivize individuals to plan early was a good idea for a number of reasons: First , monthly premiums are based on your age when you apply. This makes premiums less expensive when you’re younger. Second , people often wait until their late fifties or later to buy long-term care insurance without realizing that predicting the withdrawal of the benefits is problematic - we rarely know when we will need long-term care. A stroke or a heart attack can happen to people in their forties or fifties. Third , coverage is dependent upon your current health status. If you have a sudden heart attack or injury and have an extended hospital stay, the chances of getting a long-term care policy afterward dwindle away to almost nothing because of your preexisting condition. It’s best to buy your policy when you’re young and healthy because not everyone can qualify if they wait longer. This is particularly true for those with a family history of Alzheimer’s. These individuals are more likely to use long-term care for a longer period of time, which makes it even more important to consider buying long-term-care insurance early before you may show symptoms and buy a longer benefit period than the average of three years. I bought my policy before I turned forty. No one in my office at the time had heard of someone buying a policy this young. I had a good reason. For years, I had been calling home to my mother in China, and every time we spoke, she told me how difficult it had been for her to visit my uncle, who had Alzheimer’s and no longer recognized her. He was the oldest brother who put her through college after my grandfather died; he was like a father to her. After nine difficult years with Alzheimer’s, my uncle passed away, and this made me realize how important it is to have long-term-care insurance, not just so that you get adequate care as you decline mentally or physically, but also so that the estate you’ve worked so long to build isn’t used to pay for this care or for modifications to your home if, for example, you can’t climb the stairs. With the high cost of this care, paying out of pocket could leave your family penniless. The costs of long-term care often exceed what the average person can pay from their income and other assets. If you think about all the possible health scenarios you could face in your life, it becomes apparent that a financial plan that doesn’t include long-term-care planning is not comprehensive. Too often, people focus on investment planning or college or retirement planning without considering what would happen to their wealth if they were suddenly faced with the cost of long-term care, which can be upward of $7,000 a month. If you or your spouse needed two or three years of long-term care, that could significantly derail your retirement plans. It’s important to be smart about your resources now so that you don’t leave yourself open to that amount of risk. Very often, people do not plan ahead. This is due to a reluctance to think about getting older, developing a disability, becoming less independent, or needing help with personal care. At the same time, they often believe that health insurance, Medicare, and/or disability coverage will cover most long-term-care services should they be needed, so they don’t need to dwell on illness and aging. Health insurance, Medicare, and/or disability coverage is very limited in its coverage. That means people are often living with a false sense of comfort that their needs, should they have any, will be taken care of long-term. Thanks for bringing your head out from under the covers to read about long-term care. If you’d like to have a more personal conversation about what options and plans may be best for you, please get in touch with me today.
By Fang Huang 12 Jan, 2022
For the 11th year in a row , president and founder Echo Huang was awarded the 2022 Five Star Wealth Manager award . Using an in-depth research methodology with 10 objective criteria, including client retention rate, client assets, and households served, this award honors top local investment professionals for their commitment to professional excellence. "I help clients build financial confidence to follow their passions and dreams." -Echo Huang
By Fang Huang 28 Sep, 2021
Just about everyone wants to give their kids a head start in life, and building generational wealth is an effective way to do it. Join me at the next Master Your Money live event (free virtual hour-long bootcamp), “H ow to Create Generational Wealth” at 11 am CT on October 5, 2021. We will discuss the different forms of generational wealth, why it's so much harder to create for some communities than for others, and how you can start building wealth that will outlast you.
11 Tax Changes You Need to Know in House Democrats’ Plan
By Echo Huang 25 Sep, 2021
Democrats on the House Ways and Means Committee released their tax proposals on September 13, 2021. The measures are very different from what many expected.
By Fang Huang 28 Jun, 2021
Echo recently spoke on the Lead Your Day with Merilyn podcast about how to make wealth management simple. On the show she discusses what a financial independence day means, planning your retirement, and the necessary basic knowledge for portfolio management.
By Fang Huang 26 May, 2021
Echo sat down with Brave by Design to share her personal story and talk about all things financial planning. It's an inspiring conversation that touches on everything from how to find inspiration to how to create a solid financial plan for a bright future.
By Fang Huang 19 May, 2021
There is nothing more frustrating than finances being a reason that you can't do something. Recently Echo spoke on The Abundant Beans Podcast about what business owners can do to break down the many things needed to run a successful business by creating a system that has your money working for you, from tax planning to exit planning and much more.
More Posts
Share by: