Why you should contribute more to your 401(k) in 2015
- Contributions are pretax, reducing your modified adjusted gross income (MAGI), which can also help you reduce or avoid exposure to the 3.8% net investment income tax.
- Plan assets can grow tax-deferred — meaning you pay no income tax until you take distributions.
- Your employer may match some or all of your contributions pretax.
For 2015, you can contribute up to $18,000. If your current contribution rate will leave you short of the limit, consider increasing your contribution rate through the end of the year. Because of tax-deferred compounding, boosting contributions sooner rather than later can have a significant impact on the size of your nest egg at retirement.
If you’ll be age 50 or older by December 31, you can also make “catch-up” contributions (up to $6,000 for 2015). So if you didn’t contribute much when you were younger, this may allow you to partially make up for lost time. Even if you did make significant contributions before age 50, catch-up contributions can still be beneficial, allowing you to further leverage the power of tax-deferred compounding.
Have questions about how much to contribute? Contact Jim Komos at firstname.lastname@example.org or 216.831.7171. We’d be pleased to discuss the tax and retirement-saving considerations with you.
Opening the “back door” to a Roth IRA
A potential downside of tax-deferred saving through a traditional retirement plan is that you’ll have to pay taxes when you make withdrawals at retirement. Roth plans, on the other hand, allow tax-free distributions; the tradeoff is that contributions to these plans don’t reduce your current-year taxable income.
Unfortunately, modified adjusted gross income (MAGI)-based phase-outs may reduce or eliminate your ability to contribute:
- For married taxpayers filing jointly, the 2015 phase-out range is $183,000–$193,000.
- For single and head-of-household taxpayers, the 2015 phase-out range is $116,000–$131,000.
You can make a partial contribution if your MAGI falls within the applicable range, but no contribution if it exceeds the top of the range.
If the income-based phase-out prevents you from making Roth IRA contributions and you don’t already have a traditional IRA, a “back door” IRA might be right for you. How does it work? You set up a traditional account and make a nondeductible contribution to it. You then wait until the transaction clears and convert the traditional account to a Roth account. The only tax due will be on any growth in the account between the time you made the contribution and the date of conversion.
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2015 Summer State Tax Update