Backdoor Blues
These days , nothing is more taxfashionable for a high-income client than a backdoor Roth conversion , in which the client makes a non-deductible contribution to a traditional individual retirement account and then converts it to a Roth , ideally paying tax only on a minimal increase , if any , in the account ’ s value from the initial contribution until the conversion .
But a common mistake is “ failing to gather an understanding of whether the client has other pretax IRAs ,” says Christopher Fundora , director of retirement planning at Traphagen CPAs & Wealth Advisors in Oradell , N . J . Besides the IRA the client wants to convert , having another traditional IRA , or a rollover IRA , SEP IRA or SIMPLE IRA , can subject the conversion to the exasperating pro rata rules . These can render a large part of the conversion taxable , depending on the client ’ s circumstances , although the clients can avoid that by rolling those IRAs into a solo 401 ( k ), employer plan or another corporate retirement vehicle , Fundora notes .
“ A backdoor Roth needs to be considered in the context of the client ’ s aggregate retirement portfolio structure ,” he says , adding , “ In the case of a married couple , both spouses can take advantage of a backdoor Roth even if one does not earn wages .”
Not Enough
Some clients aiming to maximize 2023 contributions to employer-sponsored retirement plans “ are coming up short ,” reports Bruce Primeau , president of Summit Wealth Advocates in Prior Lake , Minn . Indexing has boosted the ceiling on 401 ( k ) contributions from $ 27,000 last year to $ 30,000 this year for taxpayers 50 and older . “ That ’ s a substantial increase , and some clients didn ’ t adjust their contribution to account for it ,” Primeau says . He says advisors should review their clients ’ contributions and project them through December 31 .
Advisors should check clients ’ withholdings , too . The interest rate the IRS currently charges on tax underpayments has soared along with interest rates in general , Schwier points out .
You can help your clients and prospects avoid interest ( plus penalties ) by verifying that they meet the estimated tax safe harbor — in other words , that they ’ ve paid in to the feds , through withholding and estimated tax payments , at least 100 % of their 2022 total income tax , or 110 % of it if last year ’ s adjusted gross income topped $ 150,000 ($ 75,000 for married individuals filing separately ).
“ Many of our clients , as long as they won ’ t have to pay interest or a penalty , are fine knowing they ’ ll owe the IRS at tax time . They ’ d prefer to have the money collecting 5 % interest until April 15 rather than give it to the government early ,” Schwier says .
You can help your clients and prospects avoid interest ( plus penalties ) by verifying that they meet the estimated tax safe harbor .
And One For Entrepreneurs
“ Beginning in tax year 2023 , sole proprietors are able to set up a selfemployed 401 ( k ) plan before their tax filing deadline , including extensions , and make contributions for the prior year ,” says Roger Morrissette , the vice president of small business retirement products at Fidelity Investments who works out of Smithfield , R . I .
Previously , business owners had to establish these plans by year ’ s end to get a current-year deduction . Morrissette says Fidelity anticipates the new rule “ will result in greater participation ” in these plans .
That ’ s good for entrepreneurs . A solo 401 ( k ) lets them contribute as both employee and employer , offering larger deferrals than other plans , up to $ 66,000 for 2023 or , for clients 50 or older , $ 73,500 .
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NOVEMBER 2023 | FINANCIAL ADVISOR MAGAZINE | 49