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Paying Taxes - Now, Later or Never Again?

| June 03, 2015
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by Nick Hughes

Lots of Americans are passionate about taxes. Many would like to pay fewer taxes, so they fervently embrace tax-free opportunities. You know you’re a tax-free fan if you:

• Always shop in the duty-free store when you come through customs.
• Contribute to 529 plan accounts for all your grandchildren.
• Hold off on purchases until your state’s sales tax holiday.
• Have considered moving (or moved) to a state such as Alaska, Florida, Nevada, South Dakota, Texas, Washington, or Wyoming that has no state income tax.
• Help subsidize family members by gifting each year.
• Invest in municipal bonds for the tax-free income.
• Really want to contribute to a Roth IRA.

Roth IRAs are tax-advantaged accounts that can hold many different types of assets and investments. Unlike Traditional IRAs, which offer pre-tax contributions and tax-deferred growth potential, Roth IRAs have taxable contributions with tax-free growth potential. Distributions are tax-free, too, as long as the investor is age 59½ or older and has owned the IRA for at least five years. As an added bonus, there is no minimum distribution requirement for Roth IRAs, so the money has the potential to grow and compound tax-free for decades.7


Earn too much to contribute to a Roth?

If you expect to be in the same or a higher income tax bracket during retirement, a Roth IRA may be a particularly attractive option. However, not everyone can make contributions to one. Roth IRAs have income limitations. For the 2015 tax year:

Single individuals, heads of households, or married couples (filing separately) who earn $116,000 up to $131,000 can contribute a reduced amount to a Roth IRA. If they earn more than $131,000, they are not eligible to contribute to a Roth IRA.

Married couples, filing jointly, or qualifying widow(er) who earn $183,000 up to $193,000 can contribute a reduced amount to a Roth IRA. If they earn more than $193,000, they are not eligible to contribute to a Roth IRA.

While income determines whether a person can contribute to a Roth IRA, it has no bearing on Roth ownership. As a result, anyone of any income level can have a Roth IRA. And, because of that, there are ways for high-income earners to reap the benefits of Roth IRAs without making contributions directly.


Converting to Roth IRAs

In 2010, the income limits that prevented high earners from converting assets from Traditional IRAs into Roth IRAs were removed. As a result, Americans can make contributions to Traditional IRAs and then rollover those assets into Roth IRAs. When this happens, the taxpayer will owe taxes on the amount of the rollover.

For 2015, taxpayers can contribute up to a maximum of $5,500 to IRAs. If you are age 50 or older, you can contribute up to $6,500 for the year.

Backdoor Roth Conversions

Those who are unable to contribute to Roth IRAs are typically unable to get deductions on IRA contributions as well.  For many they can contribute directly into a non-deductible IRA and immediately make a tax-free conversion to a Roth IRA.  It is important that you consult with your tax advisor and financial planner to make sure that all the existing assets in your IRAs are eligible for tax free conversions.  The government reserves the right to tax the previously un-taxed gains and deductible contributions from years past.


Contribute to a Roth 401(k), 403(b), or 457(b) plan

Some companies and organizations allow participants in 401(k), 403(b), or 457(b) plans to make contributions to designated Roth accounts. The contributions are taxable, but any earnings grow tax-free and distributions are tax-free as long as certain requirements are met. A key difference between designated Roth accounts and Roth IRAs is required minimum distributions must be taken from Roth plan accounts at age 70½.

While it is permissible to divide your annual plan contribution between designated Roth 401(k) contributions and traditional pre-tax 401(k) contributions, the total contribution amount cannot exceed $18,000 for 2015. If you are age 50 or older, you may be able to contribute an additional $6,000 to an employer's plan this year.


Make after-tax contributions to a 401(k) plan

If you have the option to make after-tax contributions to your retirement plan at work, you may want to take advantage of the opportunity. After-tax contributions are similar to non-deductible contributions to Traditional IRAs. The plan participant pays taxes on the contributions and any earnings grow tax-deferred until they are taken from the account. When a distribution is taken, the amount is taxable as ordinary income.

The IRS recently ruled the after-tax portion of a distribution can be rolled over into a Roth IRA when a plan participant leaves an employer or retires. Forbes explained it like this:

“There are new rules for taking after-tax money out of your 401(k), and they are taxpayer-friendly. Basically, if you have after-tax money in your 401(k) retirement account, you can roll it into a Roth IRA where it will then grow tax-free (as opposed to tax-deferred). You don’t have to pay pro rata taxes on the distribution, accounting for the percentage of the pre-tax money in your 401(k).”

Not all employer-sponsored plans include provisions making after-tax contributions possible. Check with your human resources department to find out whether your plan does.

If you’re passionate about taxes and would prefer to have tax-free income during retirement, ask your financial advisor about Roth strategies and how they may benefit you.


Data as of June 1st, 2015


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Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Franklin Wealth Management), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Franklin Wealth Management.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Franklin Wealth Management is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of Franklin Wealth Management’s current written disclosure statement discussing our advisory services and fees is available for review upon request.  


Joe D. Franklin is President and Founder of Franklin Wealth Management.

Joe Franklin, CFP, is founder and president of Franklin Wealth Management, a registered investment advisory firm in Hixson, Tennessee. A 20-year industry veteran, he contributes guest articles for Money Magazine and authors the Franklin Backstage Pass blog.  Joe has also been featured in the Wall Street Journal, Kiplinger's Magazine, USA Today and other publications.

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