Tax Traps, Backdoor Roth Conversion
This time of year, now more than ever, we are asked a lot of questions about how to save taxes. Here are a handful of common tax traps and a backdoor Roth conversion that you might enjoy learning about.
Typical Tax Traps
Many retired folks, especially early on, fail to make their required distribution from their IRAs. Inheritors, remember you also have to take RMDs (required miminum distributions) from any IRA you've inherited. The penalty is 50%!
Conversely, some clients want to make early distributions from retirement accounts. Make sure to talk to your financial planner and/or tax pro to help you avoid the 10% penalty. For example, pulling out money for a first-time home purchase is penalty-free in an IRA but not in a 401(k)!
Business owners have a host of tax challenges. Failing to pull out the correct amount for payroll tax could actually send a business owner in jail, plus financial penalties.
Health insurance is required for individuals and the penalties for not having it are going up every year. If you have questions, call your financial planner.
Foriegn accounts with more than $10,000, including offshore gambling accounts, must be reported. Don't make that mistake or the penalty could be 50% of the account!
Other Tax Traps for IRAs
Morningstar has put together this list of Top 10 IRA Errors. As always, call your planner if you're curious about any of them.
1. Making the wrong contribution type.
2. Not splitting between contribution types if you're not sure.
3. Assuming IRA choice is irrevocable.
4. Making a traditional nondeductible IRA contribution and leaving it be.
5. Executing a backdoor Roth with other taxable IRA assets in the picture.
6. Not being deliberate about the backdoor conversion.
7. Forgetting about spousal contributions.
8. Misunderstanding the rules about IRA contributions later in life.
9. Not using your IRA to address portfolio issues.
10. Not taking advantage of the IRA's tax-saving features.
Read more from our source on Morningstar.
Backdoor Roth IRA Conversion
You can make an IRA contribution even if your income is higher than the limits, but you cannot deduct it. It's called a nondeductible IRA. Instead of leaving it in the IRA, convert it to a Roth IRA and the growth is never taxed again. It's a backdoor Roth IRA conversion strategy. See this video from Mr. Kitces and talk to your planner to make sure you stay within the rules. As you're sure to find out, some spendthrifts in Congress may view this as a tax loophole they want to close, and so you might want to learn about it sooner rather than later.