With IRA season in full swing, financial advisors should consider ways in which their clients might use an IRA as part of their financial planning efforts. Here are seven IRA strategies to consider for clients.
For clients who are divorced and receiving alimony, these payments are counted as earned income and they can make IRA contributions even if this is their only source of earned income. All income and deductibility limits regarding IRA contributions will apply here, the same as earned income from employment or any other source. (For more, see: How to Avoid IRA Sabotage.)
Spousal IRAs for Non-Working Spouses
This is an ideal vehicle for a spouse who might be staying at home to care for children. The non- or low-wage earning spouse can contribute to a Roth or traditional IRA as long as their spouse is working and the couple files a joint tax return. This is not a special type of account, but rather a rule that allows the non-working spouse access to the tax advantage benefits of an IRA in order to continue to save for their retirement.
Those who are 50 or over at any point during the year are eligible to make a catch-up contribution of an extra $1,000 in addition to the $5,500 that all investors are allowed. This is not a huge amount, but every extra bit of savings can help your clients, especially those who may be behind in their retirement savings. The catch-up contribution applies to both Roth and traditional IRA accounts. (For more, see: 6 Essential Retirement Planning Tips.)
Automatic IRA Contributions
Many investors don’t think about their IRA contributions until tax season as the deadline is generally April 15 (April 18 for 2016) for making your IRA contribution for the prior year. Instead of waiting until just around tax time, you might advise your clients to set up automatic monthly contributions. This is a great way for them to dollar cost average. Just make sure that if they are looking at a Roth IRA that their income won’t exceed the income caps. In reality clients have 15½ months to make their contributions to an IRA for a given year and this can result in low monthly contributions for clients who would like to go this route.
Funding an IRA for a Child or Grandchild
If clients are looking to make a gift to a child or grandchild who works you might suggest funding an IRA, especially a Roth IRA for them. The annual gifting limit is $14,000 per year so the $5,500 limit (or their earned income if lower than that amount) is well within that limit. This is an excellent gifting vehicle and will get this young person off to a good start with their retirement savings efforts once they start working for real after college.
Non-Deductible IRA Roth Conversion
Even if your client’s income is too high to make a Roth IRA contribution, they can still make a contribution and use a “back-door” Roth conversion. This strategy entails making a non-deductible contribution to a traditional IRA account and then converting that amount to a Roth IRA. If this is the client’s only traditional IRA account, there should be little or no income tax liability on the conversion. The only taxes would be on any earnings in the account between the time of the contribution and the time of the conversion. (For more, see: Top Strategies for Tax-Free Roth IRA Conversions.)
There are no income limitations restricting the ability to make a non-deductible IRA contribution. However, if your client has other traditional IRAs where the contributions were made on an after-tax basis, these accounts will be counted and the client’s tax liability will be a pro-rated percentage of their total IRA accounts. For example, if they had $55,000 in total assets in traditional IRAs and $5,500 of this was made with after-tax funds, the amount of the conversion subject to income taxes would be:
Total IRA Assets $55,000
After-tax portion $5,500
Ratio of after-tax 10%
Taxable portion is 100% less the 10% after tax = 90%
So in this example if the client wanted to convert the $5,500, 90% or $4,950 would be subject to federal taxes upon conversion. Also note that if the client’s state has an income tax then this conversion would most likely be subject to the applicable state income taxes as well. A Roth conversion can be a great way to provide your clients with tax diversification as they head into retirement and can also be a great estate planning strategy. These benefits need to be weighed against any tax implications before proceeding. (For more, see: Pros and Cons of Creating a Backdoor Roth IRA.)
Consolidating Old Retirement Accounts
One of the best uses of an IRA account is as a place to consolidate a client’s various old retirement accounts. Many clients have “financial clutter" in terms of old IRA and 401(k) accounts that are scattered at various custodians and are not being properly managed. Opening an IRA at the most desirable custodian and rolling all of these accounts over can be a good way to help you and your client get your arms around these assets and manage them properly.
The Bottom Line
There are any number of solid uses of an IRA account for your clients. They should be considered, when appropriate, in the course of the financial planning work that you do for them. (For more, see: How Advisors Can Manage Evolving Retirement.)