IRA Strategies for 2021

Editor's note: Since this video was recorded, the U.S. tax filing and IRA contribution deadlines have been extended to May 17, 2021. Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Tax Day, which is April 15 this year, will be here before we know it. And that's also the deadline for making IRA contributions if you want them to count for the 2020 tax year. Joining me today to talk about some IRA strategies is Christine Benz. Christine is Morningstar's director of personal finance.

Hi, Christine. Thank you for being here.

Christine Benz: Hi, Susan. It's great to be here.

Dziubinski: Let's start out by talking a little bit about whether there have been any IRS rule changes regarding IRA contributions that people need to know about.

Benz: Well, the contribution amounts are staying the same for 2020 and 2021, so it's $6,000 maximum contribution if you're under age 50, it's $7,000 if you're 50 plus. That's staying the same. But one thing we see every year is a little bit of a change in the thresholds for eligibility to make contributions, so the income that you can have to be able to make Roth contributions or traditional IRA contributions if you want to deduct them on your tax return. So, for the traditional deductible contributions, the income limits are the lowest. They are a little higher for Roth. Check that out because we do see those change a little bit from year to year.

Dziubinski: Let's say someone finds out that they are eligible to make either a traditional IRA contribution or a Roth IRA contribution. How do they choose?

Benz: Well, this is a fork in the road for a lot of investors in 401(k) plans as well, I should say. The key thing you want to think about, and admittedly this can be a little bit tricky, but you're basically thinking about your tax rate at the time that you're making that contribution versus what you expect it will be when you pull the money out in retirement. So, for younger investors whose incomes aren't very high today, especially if they think their career is, kind of, on an upward trajectory, this is a fairly easy call. I think that the math would tend to favor the Roth contributions.

On the other hand, the example I sometimes use where a traditional deductible contribution is warranted is the older worker who hasn't managed to amass a lot of retirement savings where their income is fairly robust, but they can still make that deductible contribution. In that case, the deduction that they would get with that pretax traditional deductible contribution, that's more attractive for them. It's tricky, especially for younger people, but you want to think a little bit about that issue. And then, for some investors, Susan, especially higher-income folks, they may be shut out of direct traditional deductible IRA contributions and direct Roth IRA contributions. Their only option is to make a traditional IRA contribution, which they won't be able to deduct on their tax return because they earn too much, And then they can do what's called a backdoor Roth IRA conversion or make the contribution through the back door.

Dziubinski: So, the backdoor IRA contribution is still an option for people?

Benz: It is. It's alive and well. And I'll just run through this one more time, Susan, for people who aren't familiar with what this means. This basically means that if you earn too much to make a direct Roth IRA contribution, you can still make that traditional IRA contribution that's nondeductible. And then, shortly thereafter after you've funded that traditional IRA, then you convert to a Roth IRA. Get some tax advice here because there are some things you can run into, specifically if you have other rollover traditional IRA assets, you want to be careful. So, get some tax advice before embarking on this. But the idea of doing that conversion is that you can get some money into a Roth IRA even if you earn too much to make direct Roth IRA contributions.

Dziubinski: Now, one thing that might have flown under the radar for some people is that the SECURE Act did away with the age limits on making traditional IRA contributions. So, if you are an older investor and you are thinking about making a contribution, what do you need to know?

Benz: Right. This question comes up a lot. And the key thing I would say is that for older investors, especially ones who are subject to required minimum distributions, the key thing you need to know is that you need earned income to make a Roth IRA contribution or any IRA contribution. And so, that is a key dividing line for a lot of older adults, where if they don't have earned income--instead all their income is coming from Social Security, or coming from their portfolio, coming from required minimum distributions--they cannot make any sort of IRA contribution. What the SECURE Act did is that it opened up traditional IRA contributions to older adults. Previously, anyone could make a Roth IRA contribution regardless of age. Now, traditional IRA contributions are opened up.

My bias is for older adults who do have earned income that in most cases the Roth IRA contributions would tend to make more sense. The key reason is that if you make a traditional IRA contribution later in life, you're contributing to that amount of your portfolio that's going to be subject to required minimum distributions--if not right now, then eventually. But Roth IRA assets currently are not subject to those are RMDs, which tends to mean in my mind that Roth IRA contributions are generally preferable in this situation.

Dziubinski: And Lastly, Christine, one thing you've talked about in the past is that IRA contributions, new contributions, are a great way to upgrade your portfolio. What do you mean by that?

Benz: I love the idea of people using their new IRA contributions to address problem spots in their portfolios. So, if you are someone who is looking at your portfolio today and say, I probably am a little bit too aggressive given my age. It's not a bad time to look at adding those funds to safer assets. Or perhaps you're someone who is underweight foreign stocks, and we've been hearing a lot about how foreign stocks might be relatively attractive over the next decade alongside U.S. Well, you could direct your new contributions to foreign stocks. So, start with a little bit of a view of your portfolio, look at your portfolio's exposures, and use them to help you decide where to direct your new IRA contributions. If you have holdings that are all-in-one holdings that you're perfectly happy with, that's fine too. Just keep doing what you're doing. But for investors who have discrete holdings in their portfolios, I think this is a good opportunity to top up areas where you may be underweight.

Dziubinski: Well, Christine, thank you for all of these super IRA contribution ideas today. We appreciate your time.

Benz: Thank you, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.