We’ve all heard the saying “money doesn’t grow on trees”, but it sure would be nice not to pay Uncle Sam when it’s time to collect the newly borne fruit of your labor in the form of your hard-earned money appreciating over the years, with potentially rewarding compounding effects.

Roth IRAs (Individual Retirement Accounts) are arguably the most attractive qualified accounts available to individuals with features like tax free growth and tax free distributions.

If you want to start contributing to a Roth IRA as part of your retirement strategy, keep in mind that there are limits. When you start taking withdrawals from your Roth IRA after retirement, in most cases your distributions will be tax free since the money you put into your Roth IRAs is post-tax dollars and the key feature of the Roth IRA is tax-free accumulation. You should be aware that at least one of your Roth IRAs needs to be open for at least five years and that you must be at least 59 ½ old in order to withdraw accumulated earnings without negative repercussions.

Here are the different ways you may be able to save into a Roth IRA account:

1. Roth IRA Contribution

This is the most common way that eligible individuals can put money away into a Roth IRA. As long as you are under or within the Adjusted Gross Income (AGI) limit, you should be able to add to your own Roth IRA (Individual Retirement Account).

Typically, you would be writing a check to the Roth IRA custodian of your choice (for your benefit) and would indicate if the contribution is for the prior or current year. You are able to add money for prior year contribution all the way up to the tax deadline. Make sure you work with your independent tax advisor to determine if you are eligible for the Roth IRA and determine the amount you can put in.

Assuming you are under the AGI (Adjusted Gross Income) limit, the contribution limits for 2021 are upwards of $6,000 for people under the age of 50, and if you are at least 50 years old you are eligible for a catch of $1,000. This would make the total of $7,000 for folks over age 50.

2. Traditional IRA (deductible or non-deductible) to Roth IRA Conversion

The rules of Roth IRA conversions are complex, so it’s a good idea to work with your independent tax advisor and financial planner to determine an efficient strategy of how much Roth IRA conversion you should consider doing each year.

In general, when someone does a conversion from a pre-tax IRA account into a Roth IRA account, it is treated similarly to an IRA distribution where one must pay ordinary income tax on the amount taken out. With a Roth IRA conversion, the concept is the same regarding paying the taxes, however instead of getting a distribution into your bank account, the money goes into the Roth IRA.

One interesting component of Roth IRA conversion is that you don’t have to liquidate your investments in order to do the conversion. What makes this very attractive is the smaller tax bill that is due if you are able to do it during market drawdowns, as the taxes that you pay will be based on the market valuation of the securities at the time of the conversion. Then when the investments are successfully converted to a Roth IRA (which you would convert with “in-kind” transfer), the potential recovery in the market will now be inside your tax-free Roth IRA account!

One wrinkle to keep in mind regarding Roth IRA conversions is the “pro-rata rule”. If your Traditional IRA contains both pre-tax dollars and after-tax dollars, please consult your tax advisor to make sure you are following the proper conversion procedures.

Another interesting strategy that my clients utilize is the spousal non-deductible IRA contribution which is then converted to a Roth IRA. In some circumstances, some spouses do not have Pre-Tax IRA’s which makes this strategy very appealing. They are able to add money into a non-deducible IRA each year and then execute a Roth IRA conversion without paying any extra taxes since the contribution itself was made with after-tax dollars. Again, please consult your tax advisor to make sure you and your spouse are eligible for a non-deductible spousal IRA contribution.

3. After-Tax 401k contribution and rollover to Roth IRA

One of the little known strategies for funding a Roth IRA is through 401k after-tax contributions. This is a different strategy than doing a regular Roth IRA contribution. You will need to do some research to determine if your 401k employer sponsored plan allows this feature. I also help my clients research and analyze their existing 401k plans to see if this is something that is available to them. Some employer 401k plans allow for not only funding the 401k with after-tax dollars, but also the ability to do an in-service rollover to move the after-tax dollars into a Roth IRA even while the employee is still employed with the company. The employee is also able to do this strategy while being under the age of 59 ½.

In the year 2021, assuming the 401k plan is well designed, an individual who is over the age of 50 can save $64,500 into their 401k plan. This number is made up of employee pre-tax/Roth 401k contributions, employer matching contributions, and employee after-tax contributions. It is important to understand the capabilities of your 401k to successfully save for your retirement in the most efficient way. If someone is under the age of 50, their potential limit is $58,000.

Employees also need to be aware of the annual limit on compensation which is currently $290,000 in the year 2021. If an employee is an executive earning high compensation, they need to attempt funding the maximum 401k limit available to them prior to the $290,000 compensation cut off. In some cases, with highly compensated executives, this could be only a handful of paychecks. Make sure you work with your financial planner and tax professional to plan in advance and take full advantage of the 401k capabilities through your employer sponsored plan. I’m available to answer questions regarding 401k payroll deduction calculations and how to set up 401K contributions to get to the maximum available limits within a specific amount of pay periods.