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Before You File Your Taxes ... Consider Making a 2018 IRA Contribution (It's Not Too Late!)

As your 2018 tax statements start to come in and you're getting the ball rolling to file taxes, I want to remind you that it's not too late to make a 2018 retirement contribution--up to $5,500, or $6,500 if you're 50 or older--to an Individual Retirement Account (IRA).

Anyone with earned income (i.e., salary or wages) is eligible to contribute to an IRA up to the annual limit (or the amount of your earned income if below the annual limit). You can make a 2018 IRA contribution up to the date that you file your 2018 taxes (with the latest date being April 15, 2019).

But I Thought I Wasn't Eligible for an IRA?

Often when people think of an IRA, they think of tax deductibility, or the ability to invest pre-tax money similar to a 401(k) plan. This is how a traditional IRA works. Higher-income wage earners may (correctly) believe that they are disqualified from enjoying the tax benefits of a traditional IRA because: 1) they or a spouse participate in an employer-sponsored retirement plan; and 2) they make too much money (see 2018 IRS income limits).

If this is your situation, consider the Roth IRA. In addition to being a useful, tax-advantaged savings vehicle, the Roth IRA offers some additional estate planning benefits.

The Roth IRA Option

Roth IRA contributions are made after taxes, and it does not matter if you already participate in an employer retirement savings plan. While you won't get a tax deduction up front, the funds in a Roth IRA grow tax-deferred and qualified withdrawals are not taxed.* This means all of the investment earnings over time are yours to keep tax free--especially good news for younger savers who have a lot of time for their investments to appreciate. But even those closer to retirement can benefit.

Unlike the traditional IRA, there is no requirement with the Roth IRA to take required minimum distributions (RMDs) starting at age 70½. If you work part time in retirement, you can also continue to fund a Roth IRA.

And if you end up not needing to use the funds yourself, you can leave them to a beneficiary--a powerful estate planning tool. While your beneficiary will be required to take distributions based on life expectancy, these will be tax free (and the rest of the inherited Roth will continue to grow tax deferred).

But wait a minute. Doesn't the Roth IRA also have income limits for eligibility? Yes, it does, but keep reading ...

Roth through the Back Door

The IRS does define income limits to qualify for a Roth IRA. But even if your adjusted gross income (AGI) is over the limit, the IRS allows a "back door" method for higher-income individuals to take advantage of the Roth IRA benefits.

It's actually quite simple. You first make an after-tax contribution to a traditional IRA, which has no income criteria for after-tax savings. Then you can immediately convert the account to a Roth IRA. Done.**

Note: Be aware that if you use the back-door method to convert pre-tax contributions (or a mix of pre-tax and after-tax contributions) from a traditional IRA, you may need to pay taxes on the pre-tax portion and any earnings realized from those contributions prior to the conversion. Pre-tax funds may also be treated as income at the conversion, which can have potential implications for your tax bracket. Be sure that you understand the tax implications before deciding to do a conversion of any pre-tax contributions.

Roth IRAs Can Also Be for (Working) Kids

While you're thinking about saving for your own retirement, you may also want to think about helping a child or grandchild get a jump start on their savings. Just imagine what $5,500 invested today can turn into over 60+ years of compounded growth!

If a child has earned income (e.g., from babysitting, dog walking, or some other form of employment), you can open a custodial Roth IRA and fund it up to the total amount earned or the $5,500 limit, whichever amount is lower. You or another adult will be listed as the custodian, but the account will be in the child's name as the owner. As the custodian, you are responsible for documenting the child's income and demonstrating a reasonable wage rate (i.e., not $1,000 per hour).

If you choose to fund the Roth IRA for the child (as opposed to using his or her earned income), this is treated as a gift and the amount applies to your annual limit of $15,000.

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If you would like to make a 2018 IRA contribution, give us a call (you might want to give a heads up to your tax accountant as well). You will need to complete the contribution before you file your 2018 taxes. Be careful not to exceed the annual limit of $5,500 ($6,500 if you're over 50). The limit is per individual, and a penalty of 6% applies to excess contributions.

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* Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted.

** Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion. Additionally, each converted amount may be subject to its own five-year holding period. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.

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