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6 Tips for Last-Minute IRA Contributions

Christine Benz
Susan Dziubinski

Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar. IRA season is upon us. Investors have until April 15 to make a contribution if they want it to count for the 2018 tax year. Joining me to share some tips if you are among those rushing in last-minute contribution is Christine Benz. She is director of personal finance for Morningstar.

Christine, thanks for joining today.

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

Dziubinski: Good to see you. Now, we are about a month away from the deadline from making a contribution if you want it to count for 2018 and your first tip is that investors consider which might be the better fit for them, a traditional IRA or a Roth IRA. What are some of the things they need to be thinking about?

Benz: Right. So, you will hit that fork in the road if you are funding an IRA. One of the things to know is that income limits might make your decision for you. So, income limits: If you are someone who can contribute to a retirement plan at work, they are the most stringent for deductible IRAs. They are a little more generous for Roth IRAs. So, that might make your decision for you.

Assuming that you find yourself in the position where you can either make a deductible traditional IRA contribution or a Roth IRA contribution, the key thing you want to think about is your tax rate today at the time you make the contribution versus when you pull the money out in retirement. So, if you think that your tax rate is high today and you can make a deductible contribution, you are probably better off doing that--taking the tax break now because it's worth more to you than when you pull the money out in retirement and you are in a lower tax bracket. If the flip side is true, if you think you are in a relatively low tax bracket today and your tax rate is likely to go higher in the future, you are probably better off doing the Roth IRA contribution.

Dziubinski: Now, another tip for investors that you have is to not give up if you've been shut out of a Roth IRA.

Benz: Right. So, the income thresholds for Roth IRA contributions are pretty high, but high-income folks may find that they cannot make a direct Roth IRA contribution. So, the workaround there potentially is to take advantage of what's called a backdoor Roth IRA contribution. So, the idea is that you fund a traditional IRA, you can't deduct it on your tax return. If you earn too much to contribute to a Roth IRA, you automatically earn too much to make a deductible traditional IRA contribution. So, you fund this traditional IRA. It's a nondeductible contribution. Shortly thereafter you then convert to a Roth IRA, and there are no income limits on those conversions. So, it's a way for high-income folks to get some money into a Roth IRA account. You do want to get some tax advice here though because there maybe some tax consequences of doing this conversion. So, make sure that this is a good maneuver for you. Also, make sure to file what's called a Form 8606 to document that you made this contribution and also to document that you are not deducting it on your tax return.

Dziubinski: Got it. Now, another tip you have for investors is to not let analysis paralysis get in the way of deciding between the traditional IRA and the Roth.

Benz: That's right. And one thing to keep in mind is that you can reverse your contribution type. If it turns out that you made the wrong type of IRA contribution--for example, you made a traditional IRA contribution, but you really wanted to do Roth, you can actually change that later on. So, even though the recharacterization rules went away, which allowed you to change conversion, you can actually reverse an IRA contribution type. So, don't despair if it turns out that in hindsight you funded the wrong type of IRA.

Dziubinski: Got you. Now, another tip is, you know, many people will fund an IRA but then they don't necessarily invest it. Let's talk a little bit about that.

Benz: Right. Vanguard had some compelling research on this that showed people rush in the contributions to IRAs but then let the money sit there. They don't actually invest the money. Maybe they just are too busy, and they don't get the money invested in any sort of product. Well, especially if you are a person with a long time horizon until retirement, there's an opportunity cost if you are doing that year after year--if you are taking a while to get that money invested. One idea I think that you could take advantage of is simply use a target-date fund. If you don't know what you plan to invest in long-term, but you want to get the money working for you in sort of an age and situation-appropriate way, I think a target-date fund is a really good default.

Dziubinski: And the contribution limits did increase a little bit in 2019 from 2018. Is that right?

Benz: They did. So, in 2018, for people under 50, they are $5,500. They are going up to $6,000. For 2018, for people over 50, they are $6,500. Those are going up to $7,000. So, you can get a little more money working in tax-advantaged accounts for you.

Dziubinski: Then your last tip, Christine, is to help your loved ones get invested.

Benz: That's right. So, there's what's called a spousal IRA. If you have a nonearning spouse, you can make a contribution on his or her behalf. So, the name of the game is that you as the earning spouse just need to have enough income to cover both of your contributions. But that's an idea if you have a nonearning spouse in the family. And another tip to keep in mind is, if you have a child who has some earnings, you can actually contribute to a Roth IRA as long as the child has enough money to cover the contribution, enough earned income to cover the contribution. It doesn't matter whether your child has spent the money and it's long gone. You can fund the IRA up to whatever his or her earned income was last year. So, that's a trick to keep in mind to get young savers on the path toward retirement savings.

Dziubinski: Which is really important.

Benz: It is.

Dziubinski: Christine, thank you so much for your insights today. This is some terrific information this time of the year.

Benz: Thank you, Susan.

Dziubinski: Thanks. For Morningstar, I'm Susan Dziubinski. Thanks for watching.