IRAs in the Age of COVID-19
This year has seen tectonic shifts in the world of retirement accounts. Some changes—like the new limitations on inherited IRAs--have received a lot of coverage. While others, may have gotten lost in the shuffle. Here are some questions and answers that can help you sort everything out.
Q: I know the CARES Act suspended required minimum distributions from IRAs for 2020, but I took my RMD early in the year. Is there any way to put my RMD back into my IRA?
A: Yes! On June 23, the IRS announced that anyone who took a required minimum distribution in 2020 can roll those distributions back into their IRA provided the rollover occurs before August 31. Contact your IRA custodian or your financial advisor and they can help you get your money back into your retirement account.
Q: I receive a pretty good pension and I would like to contribute some of that money into a Roth IRA. Is that possible? Am I too old to contribute to an IRA?
A: There is no age limit for contributions to Roth or traditional IRAs. However, you can only contribute “earned income” to an IRA. Unfortunately, the IRS specifically excludes Social Security benefit payments, pensions, interest, dividends, and passive income from rental real estate from earned income. Alimony, child support and unemployment benefits are also excluded.
On the other hand, wages, salaries, tips or other taxable income earned while working for someone else or as a self-employed individual are included in earned income, as are union strike benefits and long-term disability payments received before retirement.
Q: I am a single tax payer. When I retired, I rolled my large 401k balance into an IRA. I am currently doing some consulting work and I would like to contribute some money to a Roth. Does my required minimum distribution count toward the income limit for making a Roth contribution?
A: Roth IRAs are still subject to contribution limits based on your modified adjusted gross income (MAGI). MAGI is defined as your adjusted gross income (which includes RMD income), plus tax-exempt interest and certain other deductions added back.
As a single tax payer, you start to lose your ability to contribute to a Roth IRA once your MAGI goes above $124,000. Once it exceeds $139,000 you can no longer contribute at all.
Q: My income is too high to contribute to a Roth IRA, but I understand there is something called a “backdoor Roth.” How does that work?
A: Income limits apply to Roth IRA contributions, but there are no income limits for Roth conversions. Consequently, one way to get money into a Roth IRA is to make a taxable contribution to a traditional IRA and then turn around and convert it into a Roth. It is a straight-forward maneuver, but you need to be careful about the IRA aggregation rule.
If you do a backdoor Roth, but already have another IRA, you must calculate your Roth conversion as if it is coming pro rata from all your IRAs. For example, suppose you want to make a $10,000 backdoor Roth contribution. Suppose further that you already have a traditional IRA balance of $90,000. Under the aggregation rule, your $10,000 is split $1,000 from your backdoor Roth contribution and $9,000 coming from your existing IRA. Instead of being a tax-free conversion, your conversion required you to recognize $9,000 in taxable income. You can get around the aggregation rule by rolling your existing IRA into a 401(k) plan, if one is available to you, prior to doing the Roth conversion.
Q: I read something about a “mega Roth conversion.” How does that work?
A: A mega Roth is like a backdoor Roth, except it uses after-tax contributions to a qualified plan (like a 401(k) plan) instead of an IRA. The term “mega” refers to the fact that the limits on after-tax contributions to a qualified plan are much higher ($57,000 in 2020) than the salary deferral limits ($19,500). At some point, you can roll the after-tax contributions into a Roth IRA. How you actually do that depends on the terms of your plan. Check with your 401(k) plan administrator to learn the capabilities and requirements of your plan.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.