Nola Kulig
Kulig Financial Advisors
Longmeadow, MA, 01116 USA
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Roth Savings Strategies for High Earners: Strategy #1 – the Back Door Roth IRA

May 30th, 2016

Roth IRAs and 401(k)s are wonderful savings vehicles. Although you cannot claim a tax deduction for them, their earnings are untaxed and there is no income tax due when withdrawn in retirement, providing some requirements are met.

Whenever possible, we recommend some portion of savings be devoted to Roth accounts. Ideally, entering retirement, one would have a mix of tax deferred savings (traditional IRAs and employer savings), taxable money, and Roth money. This provides multiple ways to draw down your accounts in retirement and provides much more flexibility in tax planning.

However, if you are a high earner while employed, it can be difficult to contribute to Roth accounts because:

  • There are limits on income for direct contributions to Roth IRAs. In 2016, Roth IRA contributions phase out starting at $184,000 for married filing jointly taxpayers, and they are completely eliminated at $194,000.
  • High earners frequently need to take full advantage of salary reduction plans at work to lower their taxes; thus, even if their employers offer Roth options, they may not feel they can take advantage.

The Back Door Roth IRA

Starting in 2010, Congress changed the rules for converting from a traditional to a Roth IRA. Beginning with that tax year, there is no longer an income limit on converting a non-deductible traditional IRA to a Roth IRA.

So how do you do this? There is one potential pitfall to be aware of, but with some planning, you can take advantage of this strategy for additional tax savings.

Important Condition Prior to Making the Contribution

Before using this approach, make sure that you do not have any SEP-IRA, SIMPLE IRA, traditional IRA, or rollover IRA money.  The total sum of these accounts on December 31st of the year in which you do Step 3 must be zero to avoid a “pro rata” calculation that can eliminate most of the benefit of a Backdoor Roth IRA.

The pro-rata rule is often referred to as the cream-in-the-coffee rule. Once the cream and coffee are combined you cannot separate them; in the same way, blending before-tax and after-tax funds in any Traditional IRA(s) cannot be separated. This is true even if you keep the before-tax amounts in a different Traditional, IRA from the after-tax amounts, as the values of all Traditional IRA(s) are combined for purposes of determining the percentage of any distribution or conversion that is taxed.

So how to deal with existing traditional IRA money?

  • Convert the entire sum to a Roth IRA. This approach is really only practical if it does not bump you into a higher tax bracket and you can afford to pay the taxes out of current earnings or taxable investments with relatively high cost basis.
  • Roll the money over into a 401K, 403B, or Individual 401K.  401Ks don’t count in the aforementioned pro-rata calculation.  Some people have even opened an Individual 401K that accepts IRA rollovers in order to facilitate a Backdoor Roth IRA.

Contribute to a non-deductible IRA

Next, make a $5,500 ($6,500 if over 50) non-deductible traditional IRA contribution for yourself, and one for your spouse.  You can use the same traditional IRA accounts every year, leaving the account open after you make the conversion.  (Most fund companies don’t close the account just because there is nothing in it most of the year).  I do this every January and place the contribution in a money market fund. Since it yields next to nothing, you will not have much in the way of gains that could be taxed at conversion; you will also not have any losses.

Convert the non-deductible IRA to a Roth

Convert the non-deductible traditional IRA to a Roth IRA by transferring the money from your traditional IRA into your Roth IRA at the same fund company.  If you don’t already have a Roth IRA account, you’ll need to open one.  This can easily be done online at most fund companies.  The transfer is considered a taxable event, but the tax bill should be zero if you initially put the money in cash as described earlier.  Once the money is transferred to the Roth, you can invest the money according to your investment plan.

The Step Transaction Doctrine

Some people are concerned that the IRS will have a problem with the Backdoor Roth due to an IRS rule called The Step Transaction Doctrine.  This rule says that if the sum of several legal steps is illegal, then you can’t do it.  Since a high earner can’t legally make a direct Roth IRA contribution, then some have wondered if the IRS will really allow them to use the back door Roth strategy.

Some experts recommend waiting a short period of time (anywhere from a day to six months) before doing the conversion so you can prove that wasn’t really your intent.  Another method to avoid the Step Transaction Doctrine is to convert last year’s non-deductible contribution this year, then make a new non-deductible contribution for this year to “introduce economic uncertainty” as to whether you’re going to convert or not.

Fortunately, many fund companies will not let you do your Roth conversion immediately; mine will not allow a conversion for about two to three months (I have not tracked the actual time, but have just gone back periodically to see if I can do the conversion yet). This helps safeguard against tripping the Step Transaction Doctrine.

When you do your Taxes

When you do your taxes for the year of the conversion, remember to fill out Form 8606 for each person funding a non-deductible IRA.

Congratulations, you are now accumulating Roth money! There are a few steps and things to be aware of, but it is not too difficult and provides you a tax-free source of money in retirement. Make it a habit to fund one every January for both yourself and your spouse if married, and head for financial independence!


Kulig Financial Advisors Featured in Financial Advisors IQ

December 29th, 2015

We were pleased to recently be featured in Financial Advisors IQ, an on-line service provided by the Financial Times for advisors. For the article, please see

Financial Advisor IQ (FA-IQ) is a member of the Financial Times family of news services covering the investment management industry, including sister publications Ignites and FundFire. Launched in 2013, FA-IQ is “all about the client” and delivers news content to help financial advisors build their practices.

Putting Recent Market Events in Context

August 26th, 2015

Because the markets have been rocky recently, I write to put these events in context. Market drops usually create an emotional response, when what we really need to do is to step back, take a deep breath, and behave rationally. If you have done planning with me, that also helps, as it creates a guidepost not only for your portfolio, but management of other financial risks that have potential to thwart your financial well being.

Putting Market Declines in Context

First, a bit of long term perspective—-really long term, in fact. Analysts have noted that since 1900, there have been 35 declines of 10% or more (commonly called a correction) in the S&P 500. Of those 35 corrections, the index fully recovered its value after an average of about 10 months.

There is no guarantee that the length of future recoveries will happen in a similar time frame, or at all. But unless you have a need for the money in the short term, consider just being patient.

Moreover, the S&P 500 more than doubled in value from March of 2009 through 2013 with an annualized return of more than 20% (!).  The S&P 500’s average annual total return over the past 50 years is 10%.Over the last few years we’ve seen outstanding results – a seven-year bull market. With long-term historical returns of the S&P 500 as a benchmark, we can see that results like that are unsustainable; your expectations may have become unrealistic.

If you did not bail out of stocks in 2008 or 2009, some investors have seen their portfolios double in value since then. It is not prudent to assume that rate of growth can continue. These recent rates of return were a gift—one that certainly should have moved you forward toward meeting your financial goals.

Market Volatility in Context

The reason we expect higher long-term returns on stocks than on cash and bonds is because they have greater volatility. There is no free lunch in the financial markets, and we have to accept volatility in times like this in order to earn the expected higher long-term returns. We take a strategic, long-term view on asset allocation, and your portfolio is invested based on your unique financial and personal circumstances.

Market timing does not work

Market timing could be the holy grail of investing, if only it could be done consistently. More typically investors end up with sub-par performance due to the extreme difficulty of getting the timing right. Despite much attention in the media to being tactical (i.e. market timing), we are not aware of investors who have consistently gotten in and out of the markets with success. Although the Holy Grail does not exist, the good news is that one does not need a crystal ball to invest with success. The benefits of a long-term, strategic view are compelling, but the higher returns associated with investing in stocks is dependent on being disciplined through both good and bad times.

The importance of diversification

One of the important lessons from the financial crisis is that diversification works. While this may not be the case on a day-to-day basis, a mix of different types of assets provides a smoother and more stable ride for your portfolio. As an example, while stocks have performed poorly in the past few weeks, most bonds have provided positive returns. The time frame is extremely short, and no one knows how assets will perform in the next few weeks or months, but it is another testament to the benefits of diversification.

If You Have a Financial Plan, You Should Sleep Well at Night

Financial well being rests on far more than just a portfolio. It is highly dependent on good savings habits, prudent management of credit, adequate insurance for risks you may face and much more. If you have taken care of these parts of your financial plan, you have addressed many of the issues which can thwart your security; in fact some of these these are far larger threats than any market volatility.

That plan would also include not putting more at risk in the markets than you can bear. If you have done planning with Kulig Financial, we have striven to resolve these issues and enhance your security.

What to Do (or not Do) Now

It is entirely possible that if you have a financial plan and have implemented it, you may not have a lot to do in response to current market events.

However, it may present a rebalancing and/or tax loss opportunity. That is where we are placing our focus for portfolios that we manage. What we are not doing, however, is changing the risk level of the portfolios, as that has been carefully designed to fit our clients’ financial situations.

As your financial fiduciaries, we care deeply about your financial well-being, and it is in times like these that it is important to stay calm and refrain from making decisions that may be detrimental to your wealth. In the meantime, we will monitor for rebalancing opportunities that may add value to your portfolio.

Investment advisor representative of an investment advisory services offered through Garrett Investment Advisors, LLC, a fee-only SEC registered investment advisor. Tel: (910) FEE-ONLY. Kulig Financial Advisors may offer investment advisory services in the state of Massachusetts and other jurisdictions where exempted.