NerdWallet's Smart Money Podcast: End-of-Year IRA Fixes Before Tax Time – Roth Contribution and Correction Strategies

Release Date: December 16, 2024

Introduction

In this enlightening episode of NerdWallet's Smart Money Podcast, hosts Sean Pyles and Sarah Rathner, alongside co-host Elizabeth Ayola, delve into the intricate world of Roth IRA contributions, especially focusing on strategies for individuals exceeding income limits. The episode, aptly titled "End-of-Year IRA Fixes Before Tax Time: Roth Contribution and Correction Strategies," provides listeners with practical advice to navigate the complexities of retirement savings as the tax year draws to a close.

The Virtue of Laziness in Financial Management

Sean Pyles and Sarah Rathner kick off the discussion by exploring how adopting a "lazy" approach to certain financial tasks can actually lead to significant benefits. They emphasize automating financial processes to ensure steady progress without constant oversight.

Lazy Investing: Dollar Cost Averaging and Target Date Funds

Sarah Rathner explains the concept of dollar cost averaging (DCA) as a hands-off investment strategy. By setting a fixed amount to invest regularly, individuals can mitigate the risks associated with market volatility.

[03:13] Sarah Rathner: “If you're feeling stuck going about investing, the lazy way could be a way to get past that. One thing to try is setting a monthly investing budget and then depositing that amount into a brokerage account to be invested.”

Sean Pyles echoes this sentiment, highlighting target date funds as an exemplary tool for lazy investors. These funds automatically adjust the investment allocation as the target date approaches, reducing the need for manual intervention.

[04:18] Sean Pyles: “Index funds, exchange traded funds, or target date funds are all perfectly fine options. Automate contributions into funds that match your goals and move on with your life.”

Savings Bucket Strategy

Sean introduces his "savings bucket strategy," which involves maintaining multiple checking and savings accounts, each designated for specific financial goals. This method ensures that money is allocated appropriately without the need for constant management.

[06:09] Sean Pyles: “I allocate specific percentages of my paycheck into each account and this is really where the magic happens. Each pay period, my money just goes into these accounts automatically.”

Sarah concurs, sharing her similar approach with her husband, emphasizing the importance of automating savings for major expenses like mortgage payments and daycare tuition.

[07:35] Sarah Rathner: “I have a savings account for my wedding, another for my emergency fund, and one for fun money—everything just happens on its own.”

Listener's Money Question: Navigating Roth IRA Contribution Limits

The episode transitions into the "Money Question" segment, where the hosts address a listener's concern about exceeding Roth IRA contribution limits due to high income.

Understanding Roth IRA Contribution Limits

Elizabeth Ayola breaks down the 2024 Roth IRA contribution limits, explaining how income levels affect eligibility. For married couples filing jointly, the contribution phase-out begins at a modified adjusted gross income (MAGI) of $228,000 and completely phases out at $240,000.

[13:05] Elizabeth Ayola: “For couples who are married filing jointly, the phase-out range starts at $228,000 to $240,000. If you earn $240,000 or more, you can't contribute to a Roth IRA at all.”

Consequences of Over-Contribution

Exceeding the contribution limit can result in IRS penalties. The hosts discuss the 6% tax imposed on excess contributions and stress the importance of addressing over-contributions promptly.

[15:49] Elizabeth Ayola: “You'll owe a 6% tax on the amount of excess contributions left in a Roth IRA every year.”

Solutions for Excess Contributions

Several strategies are outlined to rectify over-contributions:

1. Returning Excess Contributions: Withdraw the excess amount before filing taxes to avoid penalties.

   [16:07] Elizabeth Ayola: “Most IRA custodians like Vanguard and Fidelity have a return of excess contributions form that you can file with them to just get the excess money back.”

2. Recharacterizing Contributions: Convert the excess Roth contribution to a traditional IRA, potentially reducing taxable income.

   [16:57] Elizabeth Ayola: “You can recharacterize your contributions from Roth to traditional IRA when you file taxes.”

3. Amending Tax Returns: If the excess is discovered post-tax filing, amend the tax return by October 15th of the following year to avoid continued penalties.

   [17:21] Elizabeth Ayola: “If you realize you over contributed after you file, you can still recharacterize contributions if you file an amended tax return before October 15th of the following year.”

Backdoor Roth IRA Strategy

For those whose incomes exceed Roth IRA limits, the backdoor Roth IRA offers a viable workaround. This involves making non-deductible contributions to a traditional IRA and then converting it to a Roth IRA.

[18:56] Sarah Rathner: “The backdoor Roth IRA strategy involves opening a new traditional IRA, making non deductible contributions to it, and then rolling over that traditional IRA into a Roth IRA.”

Elizabeth cautions that this method involves multiple steps and potential tax implications, recommending consultation with a financial advisor.

[20:54] Sarah Rathner: “The taxes you have to pay on any investment profits, that's all in one go, so that could be potentially a pretty high tax bill all at once.”

End-of-Year Retirement Contribution Strategies

As the tax year concludes, the hosts provide actionable advice to maximize retirement contributions.

Maximizing 401(k) Contributions and Employer Matches

Contributing to a 401(k) plan, especially to take full advantage of employer matches, is emphasized as a crucial step.

[21:11] Elizabeth Ayola: “If you have a workplace retirement plan that matches your contributions, the common advice is to contribute the maximum matched amount if you're able, because it's free money and it's not counted toward your contribution limit.”

IRA Contribution Deadlines

Listeners are reminded of the extended deadline for IRA contributions, allowing them to make adjustments before the next tax filing season.

[22:19] Elizabeth Ayola: “They have until the tax filing deadline next year. That said, sooner is usually better when it comes to retirement account contributions because the longer you wait, the more investment returns you're potentially missing out on.”

Conclusion and Key Takeaways

The episode wraps up with a reinforcement of the importance of proactive financial management, especially regarding retirement accounts. The hosts encourage listeners to seek professional advice when navigating complex financial decisions and to utilize available resources to optimize their retirement savings.

[22:33] Sarah Rathner: “Use the compound interest calculator on our website to see how much your contribution could grow in the next few years.”

Notable Quotes

• Sarah Rathner on lazy investing:

  [03:13] “If you're feeling stuck going about investing, the lazy way could be a way to get past that.”

• Sean Pyles on target date funds:

  [04:18] “Automate contributions into funds that match your goals and move on with your life.”

• Elizabeth Ayola on backdoor Roth IRA:

  [19:09] “The backdoor Roth IRA strategy involves opening a new traditional IRA, making non deductible contributions to it, and then rolling over that traditional IRA into a Roth IRA.”

• Sarah Rathner on maximizing IRA contributions:

  [22:33] “Use the compound interest calculator on our website to see how much your contribution could grow in the next few years.”

Final Thoughts

This episode of NerdWallet's Smart Money Podcast serves as a comprehensive guide for individuals navigating the challenges of Roth IRA contributions, especially those facing income limits. By combining practical strategies with expert advice, Sean, Sarah, and Elizabeth empower listeners to make informed decisions, ensuring their financial well-being as the year concludes and beyond.

Resources Mentioned:

• NerdWallet's List of Best Roth IRA Accounts
• IRS Guidelines on Roth IRA Contributions
• Compound Interest Calculator

Connect with NerdWallet's Smart Money Podcast:

• Voicemail/Text: 901-730-6373
• Email: podcast@nerdwallet.com
• Website: nerdwallet.com/podcast

Disclaimer: The information presented in this summary is for educational and informational purposes only and should not be construed as financial advice. Please consult with a financial professional for advice tailored to your individual circumstances.