The Health Savings Account: Navigating Healthcare Costs

Posted on May 1, 2024April 30, 2024 by Brian Colvert

One of the most disruptive elements to any well-crafted financial plan is the unpredictable nature of medical expenses. Enter the Health Savings Account (HSA), a powerful tool that can change how you manage and mitigate healthcare costs both now and in retirement. Tune in to the most recent episode of The Field Guide Podcast, with Brian Colvert, CFP® to learn about its unique benefits and how you can navigate the ever-changing terrain of healthcare costs with confidence.

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A Health Savings Account is like a supercharged savings account specifically designed for qualified medical expenses. They offer a powerful triple tax advantage, allowing you to save money on healthcare while maximizing your tax benefits.

Today we will dive into Health Savings Accounts, exploring their advantages, eligibility requirements, and how to determine if it is the right fit for you.

The Rising Tide of Healthcare Costs: Why Health Savings Accounts Matter

A crucial factor to consider when it comes to healthcare savings: medical cost inflation. Medical expenses have historically inflated at a rate significantly higher than general inflation. This means the cost of staying healthy is likely to increase substantially over time. Whether it is prescriptions, medical insurance insurance, surgeries, or whatever else might come along, the cost of medical care is going to cost more in the future. A Health Savings Account quite possibly is the best tool out there to help you cover these costs.

Unveiling the Power of HSAs: Triple Tax Benefits

HSAs stand out for their unique ability to offer a triple tax advantage. This means you get tax breaks at three crucial stages:

Contributions: When you contribute money to your HSA, it’s deducted from your taxable income. This can significantly reduce your tax burden in the year you contribute.
Growth: The money in your HSA has the potential to grow tax-free through interest or investments offered by some HSA providers.
Withdrawals: The best part? When you use your HSA funds to pay for qualified medical expenses, those withdrawals are completely tax-free.

Let’s break down an example to illustrate the power of this triple tax benefit. Imagine you earn $200,000 annually and contribute the maximum HSA contribution of $4,150 (individual coverage under age 55) in pre-tax dollars. Assuming a 25% tax bracket, you’d effectively save $1,037.5 on taxes right off the bat.

Now, let’s say your HSA earns a 2% annual interest rate. Over ten years, your pre-tax contributions and interest earned would grow tax-free. Finally, when you withdraw those funds to pay for qualified medical expenses, you won’t owe any taxes on the withdrawal.

This triple tax advantage makes HSAs a highly attractive option for individuals aiming to save for current and future healthcare needs while minimizing their tax burden.

Making Your HSA Work for You: A Long-Term Strategy

Let’s talk about how to maximize the benefits of your HSA. Here’s a strategy we recommend: think of your HSA as a health savings bank.

Currently, the annual contribution limit for HSAs is $4,150 for individuals and $8,300 for families (with an additional $1,000 catch-up contribution allowed for individuals over 55). That’s a significant amount you can save each year towards future healthcare needs.

Here’s the key: during your working years, while you likely have a steady income, aim to cover your current medical expenses directly. This includes premiums, doctor visits, prescriptions, and anything else that comes up.

The real power of HSAs lies in their long-term potential. Instead of spending your HSA contributions right away, contribute the maximum allowed and invest those funds within your HSA. This allows your money to grow tax-free over time.

Imagine consistently contributing close to the maximum HSA limit (around $8,300 with catch-up contributions) and achieving a reasonable growth rate over a decade. You could potentially accumulate over $100,000!

This creates a significant tax-advantaged pool of funds you can tap into during retirement. You can use these funds tax-free to cover various healthcare expenses, such as Medicare premiums, surgeries, prescriptions, dental care, or vision needs.

Think of it as a tax-free safety net for your healthcare needs in retirement. By letting your HSA contributions grow over time, you reduce your reliance on withdrawing funds from taxable retirement accounts like 401(k)s or IRAs. This can help minimize your overall tax burden in retirement.

Beyond Savings: The Flexibility of HSAs

HSAs offer more than just tax-advantaged savings. They provide flexibility in managing your healthcare finances:

Wide Variety of Uses: HSAs can be used to cover a wide range of qualified medical expenses, including deductibles, co-pays, coinsurance, prescriptions, contact lenses, dental care, acupuncture, weight loss programs, and even some over-the-counter medications. Remember: It’s always best to check with your HSA provider to confirm coverage for specific expenses.
Save for Future Needs: HSAs aren’t limited to immediate medical bills. You can use them to accumulate funds for anticipated future healthcare needs, such as major dental work, vision care, or elective procedures. This allows for proactive financial planning for your health.
Portability: HSAs are portable, meaning they remain yours even if you change jobs or insurance providers (as long as the new plan is HSA-compatible). This ensures continuity and control over your healthcare savings.

Who Qualifies for a Health Savings Account?

To be eligible for an HSA, you must meet two key requirements:

High-Deductible Health Plan (HDHP): You must be enrolled in an HSA-qualified High-Deductible Health Plan (HDHP). HDHPs typically have lower monthly premiums but come with higher deductibles – the amount you’re responsible for paying before your insurance kicks in. The IRS sets annual minimum deductible amounts for HDHPs to qualify for HSA contributions. For individuals in 2024, the minimum deductible is $1,400, and for families, it’s $2,800.
Minimum Health Coverage: You cannot have any other health insurance plan that provides coverage beyond preventive care services while you’re contributing to an HSA.

HSA and Medicare

Understanding how Medicare interacts with your Health Savings Account (HSA) is crucial for managing your healthcare expenses effectively. Here’s what you should know:

Eligibility: You can’t contribute to an HSA once you’re enrolled in Medicare. This means if you’re planning to enroll in Medicare, it might be wise to maximize your contributions to your HSA before you become eligible.
Contribution Limits: If you have both Medicare and an HSA, your contribution limit to the HSA changes. You’re only allowed to contribute on a prorated basis for the months you were not enrolled in Medicare.
Qualified Medical Expenses: You can still use the funds in your HSA to pay for qualified medical expenses, even after you’re enrolled in Medicare. However, you can’t use HSA funds to pay for premiums for Medicare supplemental policies (Medigap) or Medicare Advantage plans.
Tax Implications: Withdrawals from your HSA for qualified medical expenses remain tax-free, even if you’re on Medicare. However, if you withdraw funds for non-medical expenses, you’ll incur a 20% penalty on the amount withdrawn, plus income tax (for those under 65). After age 65, you can withdraw for non-medical expenses penalty-free, but income tax is still applicable.
Medicare Premiums: You cannot use HSA funds to pay for Medicare premiums (except for certain specific circumstances, such as premiums for qualified long-term care insurance, or premiums for Medicare Part B, Part D, or Medicare Advantage, if you’re over 65).
Medicare and HSA coordination: When you enroll in Medicare, you should stop making contributions to your HSA. However, you can still use the funds in your existing HSA to pay for qualified medical expenses. Additionally, you may choose to withdraw funds from your HSA to cover Medicare premiums and out-of-pocket medical expenses.
Healthcare Costs in Retirement: While Medicare provides coverage for many healthcare expenses, it doesn’t cover everything. Having an HSA can be a valuable tool for covering co-pays, deductibles, and other out-of-pocket expenses in retirement.

Need more information on Medicare- Grab out FREE Medicare Cheat Sheet!

Is an HSA Right for You? Making an Informed Decision

While HSAs offer significant advantages, they might not be the perfect fit for everyone. Here are some key factors to consider:

Health Status: If you anticipate needing frequent medical care, the higher out-of-pocket costs associated with HDHPs might outweigh the tax benefits of an HSA.
Financial Stability: Ensure you have a financial safety net to cover your deductible in case of unexpected medical bills.
Future Healthcare Needs: If you foresee significant healthcare expenses in the future, an HSA can be a valuable tool to accumulate funds and prepare for those costs.

Maximizing Your HSA Advantage: Getting Started

If you’ve decided an HSA aligns with your financial goals, here’s how to get started and make the most of it:

Open an HSA: Many employers offer HSAs through payroll deductions. You can also open an HSA directly with wth us. Get started by booking an appointment.
Contribute Strategically: The IRS sets annual contribution limits for HSAs. Contribute as much as your budget allows to maximize your tax savings and long-term healthcare savings.
Plan for Deductible Expenses: Set aside funds in a separate savings account or budget to cover your deductible in case of unexpected medical bills. This will prevent dipping into your HSA funds prematurely and ensure you have access to tax-advantaged dollars for future needs.
Track and Manage Expenses: Maintain clear records of your HSA contributions, qualified medical expenses, and withdrawals. Many HSA providers offer online tools and mobile apps to simplify expense tracking and ensure you stay compliant with IRS regulations.

Leveraging HSAs for Long-Term Healthcare Savings

HSAs are powerful tools for long-term healthcare savings. Here are some strategies to get the most out of them for the future:

Invest Your HSA Funds: Some HSA providers offer investment options. Consider investing a portion of your HSA funds for long-term growth. Potentially outpacing inflation and accumulating a larger nest egg for future healthcare needs. Not sure where to start, book a free consultation call with us.
Pay Yourself Back: If you pay for qualified medical expenses out of pocket, you can reimburse yourself from your HSA funds later, even years down the line. Keep receipts for qualified expenses to ensure proper documentation.

Conclusion: Your Empowered Path to Healthcare Savings

Health Savings Accounts offer a unique opportunity to take control of your healthcare finances. By understanding the tax advantages, eligibility requirements, and strategic use of HSAs, you can significantly reduce your healthcare costs and build a secure financial future for your health.

Ready to explore a Health Savings Account further?

We are here to help answer any questions you may have about HSAs. Book a call with us today!

Backdoor Roth: From Tax Burden to Tax-Free Growth

Posted on April 24, 2024April 25, 2024 by Brian Colvert

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The name might sound exclusive or even clandestine, but a Backdoor Roth is simply a powerful financial tool, particularly for high-income individuals seeking tax-savvy savings strategies for retirement. In the most recent episode of The Field Guide Podcast, Brian Colvert, CFP® unpacks the intricacies of Backdoor Roth IRAs, an often-misunderstood approach to tax-efficient retirement saving. He covers everything from the basics of Roth IRAs to navigating the complexities of Backdoor conversions, offering actionable tips for maximizing wealth-building potential. Whether you’re a high-income earner or simply looking to optimize your retirement savings, this episode provides a comprehensive guide to leveraging a Backdoor Roth IRA.

Understanding Traditional and Roth IRAs

First, let’s establish a foundation by understanding traditional and Roth IRAs. Traditional IRAs allow pre-tax contributions, meaning you don’t pay taxes upfront on the invested amount. However, taxes are deferred until withdrawals in retirement, when they’re taxed as income. In contrast, Roth IRAs involve after-tax contributions; taxes are paid upfront, but growth and withdrawals are tax-free. This provides a significant advantage, especially in the long run.

The Power of Tax-Free Growth

The magic of a Roth IRA lies in its tax-free growth potential. Considering the extended time horizon of retirement planning, funds in a Roth IRA can compound significantly without the drag of taxes. This offers a valuable asset for your golden years. Additionally, the tax benefits extend beyond your lifetime. Roth assets can be passed on to heirs tax-free, providing a lasting financial legacy.

Income Limits and the Backdoor Solution

The IRS sets income limits for people who can directly contribute to a Roth IRA. These limits apply to your modified adjusted gross income (MAGI) which is basically your total income minus certain adjustments. If your MAGI exceeds the limit, you can’t contribute directly to a Roth IRA for that year.

Here’s a quick breakdown of the 2024 limits:

Single filers: Cannot directly contribute if MAGI is over $160,000
Married filing jointly: Cannot directly contribute if MAGI is over $240,000 (There’s a phase-out range between $206,000 and $240,000)

This is where the Backdoor Roth IRA strategy comes in.

The Backdoor Roth IRA in Action

The Backdoor Roth strategy involves making after-tax contributions to a traditional IRA and then converting those funds into a Roth IRA. Unlike direct contributions, there are no income limits for Roth conversions, making it an attractive option for high earners to access tax-advantaged savings.

The Pro-Rata Rule: A Potential Hurdle

This is where things get a bit more nuanced. There’s an important caveat – the pro-rata rule. When converting funds from a traditional IRA to a Roth IRA, any pre-tax amounts in existing IRAs are factored into the conversion. If a significant portion of your IRA holdings is pre-tax, the conversion will trigger taxes on a proportional basis.

Here’s a simplified example:

Let’s say you have a $10,000 pre-tax balance in an existing traditional IRA and make a $5,000 non-deductible contribution for a Backdoor Roth.
The total balance in your traditional IRA before conversion is now $15,000.
When you convert the entire $15,000 to a Roth IRA, the pro-rata rule kicks in because you have both pre-tax and non-deductible contributions.
In this scenario, the non-deductible contribution makes up one-third ($5,000) of the total balance ($15,000). So, one-third of the conversion (or $5,000) would be considered tax-free from your non-deductible contribution.
The remaining two-thirds ($10,000) of the conversion would be considered a taxable distribution from your pre-tax contributions. However, since you already paid taxes on this money when you initially contributed it, you wouldn’t owe additional income tax, but you would owe taxes on any earnings those pre-tax contributions generated within the IRA.

Minimizing Tax Implications

For individuals with substantial traditional IRA balances, exploring options to mitigate tax implications, such as rolling over funds into an employer-sponsored 401(k), might be advisable. However, for those without existing IRA balances, the Backdoor Roth presents a compelling opportunity for tax-efficient retirement savings.

Don’t Underestimate Tax-Free Growth

Despite the contribution limits on Roth IRAs, the benefits of tax-free growth shouldn’t be downplayed. Even if contributions are capped, every dollar invested in a Roth IRA has the potential to grow tax-free, providing a valuable asset for retirement. Prioritizing tax-efficient investment vehicles like the Roth IRA can significantly enhance your financial security in retirement.

Seeking Professional Guidance

Navigating the complexities of retirement planning and tax optimization can be overwhelming. Talking to a CERTIFIED FINANCIAL PLANNER™ ( CFP®) about a Backdoor Roth IRA can be really beneficial:

Eligibility and Tax Implications: A CFP® can confirm your eligibility for a Backdoor Roth IRA. There are income limits for directly contributing to a Roth IRA, and the Backdoor method is a work-around. A CFP® can ensure it makes sense for your income level and tax situation.

Pro-Rata Rule: This rule gets tricky. If you already have pre-tax money in a traditional IRA, converting to a Roth triggers taxes on some of it. A CFP® can help you calculate the tax impact and navigate the pro-rata rule to minimize any tax burden.

Optimizing your plan: The Backdoor Roth might not be the only option. A CFP® can look at your entire retirement picture and suggest the best strategy for your goals. This might include maximizing contributions to other accounts like a 401(k) before considering a Backdoor Roth.

Avoiding Errors: The Backdoor Roth IRA process involves specific steps. A CFP® can ensure you complete them correctly to avoid issues with the IRS. While you can research the Backdoor Roth IRA yourself, a CFP® brings their expertise and experience to personalize the strategy for you. They can ensure it fits your specific financial situation and helps you reach your retirement goals.

Next Steps

At Bonfire Financial, we specialize in guiding individuals through the intricacies of financial planning. We help you chart a course from your current financial position to your desired retirement lifestyle. Whether you’re exploring the Backdoor Roth or seeking comprehensive financial advice, we’re here to assist you every step of the way.

Let’s schedule a call to discuss your specific situation! Book here now!

Streamlining Retirement: Insights into Retirement Account Consolidation

Posted on April 10, 2024April 25, 2024 by Brian Colvert

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Do you have a bunch of old retirement plans scattered around? Do you have multiple different IRAs and 401(k)s from past employers? If you are nodding your head yes, then this is for you! In the most recent episode of The Field Guide Podcast, Brian Colvert, CFP® dives into the world of retirement account consolidation. We’ll explore the pros and cons of streamlining your accounts, the factors to consider when making a decision, and some key strategies when juggling multiple retirement accounts.

Why Consolidate Your Retirement Accounts?

It is important to acknowledge the bureaucratic burden of scattered retirement accounts. Imagine the frustration of receiving statements from each past employer’s plan, trying to decipher fees, and wondering if your investments are aligned with your goals. Here’s how consolidation can help:

Simplicity: Having everything in one place makes tracking your progress and managing investments a breeze. No more scrambling through multiple statements.
Control: Consolidation empowers you to make informed decisions about your investments with a holistic view of your retirement savings.
Reduced Fees: While fees might not be the deciding factor anymore, with some consolidation options, you may find lower expense ratios in your target investment choices.

Things to Consider When Consolidating Accounts:

While consolidation offers clear benefits, it’s not a one-size-fits-all solution. Here are some crucial aspects to consider before diving in:

Investment Options: Compare the investment choices available in your existing accounts with those offered by your target consolidation location (current employer’s plan or IRA). Does the new platform provide the flexibility you need to achieve your investment goals?
Fees: While expense ratios have become more competitive, don’t overlook potential fees associated with the consolidation process itself, such as transfer fees or rollover penalties.
Tax Implications: Traditional and Roth accounts have different tax implications. Depending on your income level and future tax plans, consolidating into a Roth IRA might not be an option (Brian mentions “backdoor Roth” strategies, but these can be complex and require consulting a financial advisor).

Retirement Account Consolidation Strategies: Choosing the Right Path

Now that you understand the pros and cons, let’s explore some common consolidation strategies:

Rollover to Your Current Employer’s Plan: If your current employer’s 401(k) allows rollovers and offers a good selection of investment options with low fees, this might be your best bet. It simplifies your life and potentially reduces fees.
Consolidate into an IRA: An IRA offers a wider range of investment options compared to most employer-sponsored plans. This flexibility can be valuable if you have specific investment goals or want to explore alternative asset classes not typically available in a 401(k).

Taking Action: Streamlining Your Retirement Savings

Here are some steps to guide your retirement account consolidation journey:

Gather Information: List all your retirement accounts, including account types (401(k), IRA), current balances, and investment details.
Research Options: Review the investment options and fees associated with your current employer’s plan and potential IRA custodians.
Run the Numbers: Consider potential transfer fees and any tax implications of the consolidation. There are online calculators available to help with this step.
Make a Decision: Based on your research and risk tolerance, choose the consolidation method that aligns best with your goals and financial situation.
Seek Professional Advice: For complex situations or if you’re unsure about any aspect of the consolidation process, consulting with a CERTIFIED FINANCIAL PLANNER™ is highly recommended.

Beyond Consolidation: Building a Personalized Financial Roadmap

Consolidation is just one piece of the puzzle. Developing a comprehensive financial plan that considers your income, expenses, retirement goals, and risk tolerance is crucial for a secure financial future.

The Takeaway: Consolidation Can Be Powerful, But Knowledge is Key

Consolidating your retirement accounts can simplify your life and potentially improve your investment returns. However, it’s important to understand the various factors at play, the potential fees involved, and any tax implications. By carefully considering your options and potentially seeking professional guidance, you can make an informed decision that empowers you to achieve your retirement goals.

Remember:

Consolidation might not always be the best solution.
Always consider fees, tax implications, and investment options before making a move.
A personalized financial plan goes beyond consolidation and provides and puts your entire financial life under one roof and gives you the confidence you need to move towards retirement.

Have questions or need help with retirement account consolidation?

Schedule a FREE consultation with one of our CERTIFIED FINANCIAL PLANNER™

The Power of Catch-Up Contributions

Posted on April 3, 2024April 25, 2024 by Brian Colvert

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The benefit of aging: Catch-Up Contributions

In the most recent episode of The Field Guide Podcast, Brian Colvert, CFP®, takes a fresh look at aging – not as a decline, but as a time brimming with opportunities, especially when it comes to building a secure retirement. Brian dives into the often-underutilized benefits of increasing contributions to retirement accounts as you get older, demonstrating how these seemingly small tweaks can significantly impact your financial future.

Leveraging Catch-Up Contributions: A Detailed Look:

One of the perks of aging is the ability to contribute more to retirement accounts like IRAs, 401(k)s, and HSAs. Let’s break down the specifics and explore why maximizing these contributions is crucial.

IRAs and Roth IRAs: The standard contribution limit for both Traditional and Roth IRAs for 2024 sits at $7,000. However, individuals aged 50 and above are eligible for Catch-up contributions, allowing them to add an extra $1,000, bringing their total contribution to a substantial $8,000. Don’t let high income discourage you; strategies like the backdoor Roth conversion can help you take advantage of these benefits, even if your income exceeds the Roth IRA contribution limits. Here’s a deeper dive into the backdoor Roth conversion:

Backdoor Roth Conversion: A Backdoor Roth is a strategy that involves contributing to a traditional IRA and then converting those funds to a Roth IRA. There are tax implications associated with this conversion, but for those who wouldn’t qualify for a direct Roth IRA contribution due to income restrictions, it can be a valuable way to access the tax-free growth benefits of a Roth IRA in retirement.

Company Plans: Similar benefits exist for company-sponsored plans like SIMPLE IRAs and 401(k)s. Catch-up contributions are available for those over 50, allowing them to significantly increase their contributions and accelerate retirement savings. Let’s explore some additional considerations for company plans:

Employer Matching: Many employers offer matching contributions on employee contributions to retirement plans. This essentially translates to free money for your retirement. Be sure to contribute at least enough to capture your employer’s full match. It’s like leaving free money on the table if you don’t!

Investment Options: Company plans often offer a variety of investment options within the plan. Understanding your risk tolerance and investment time horizon is crucial when choosing how to allocate your contributions within the plan. We recommend seeking guidance from a CERTIFIED FINANCIAL PLANNER™ regarding your best investment options.

The Power of Compounding Interest with Your Catch-Up Contributions

Here’s where the magic truly happens: compounding interest. Even seemingly small additional contributions can snowball into a significant sum over time. Consider this: a $1,000 extra contribution to an IRA each year, consistently invested for 15 years with a moderate 6% rate of return, could grow into over $23,000. This is the magic of compounding interest working in your favor. Let’s delve a little deeper into the concept of compounding interest:

Exponential Growth: Compound interest allows your money to grow exponentially over time. Your earnings not only come from your initial contributions but also from the interest earned on those contributions. This creates a snowball effect, accelerating the growth of your retirement savings.

Time is Your Ally: The longer your money is invested, the greater the impact of compounding interest. Starting to contribute to retirement savings early and taking advantage of catch-up contributions later allows you to maximize the power of compounding interest.

HSAs: A Tax-Advantaged Powerhouse – Unveiling the Benefits

The benefits extend beyond traditional retirement accounts. HSAs (Health Savings Accounts), often overlooked in retirement planning, offer additional avenues for saving. Individuals aged 55 and above can contribute an extra $1,000 on top of the standard limits as of 2024. Let’s explore the unique advantages of HSAs:

Triple Tax Advantage: HSAs boast a unique “triple tax advantage.” Contributions are tax-deductible, investment earnings grow tax-free, and qualified medical withdrawals are tax-free. This makes HSAs a powerful tool for saving for future medical expenses while minimizing your tax burden.

Portability: HSAs are portable, meaning the funds belong to you, not your employer. You can retain your HSA even if you change jobs, providing long-term financial security for healthcare costs.

Embrace the Silver Lining:

Growing older comes with its challenges, but it also unlocks valuable opportunities to solidify your financial future. By maximizing catch-up contributions and strategically utilizing retirement accounts, you can pave the way for a secure and comfortable retirement. Remember, you’re not alone in this journey. If you have any questions or need guidance on your retirement planning path, don’t hesitate to reach out to The Field Guide. Your financial security is our top priority.

Taking Action:

Catch-Up Contributions are just the start. Here are some actionable steps you can take today:

Schedule a consultation with a CERTIFIED FINANCIAL PLANNER™: Discuss your retirement goals and explore personalized strategies to maximize catch-up contributions and retirement savings.
Research retirement account options: Understand the contribution limits, tax implications, and investment options for IRAs, Roth IRAs, 401(k)s, and HSAs.
Review your current contributions: Analyze your current contributions to retirement accounts and consider increasing them to take advantage of catch-up provisions.
Automate your contributions: Setting up automatic contributions ensures you’re consistently saving towards your retirement goals.

By taking these steps and embracing the opportunities that come with age, you can transform your retirement from a distant dream into a fulfilling reality.

When can I retire? Navigating Retirement

Posted on March 27, 2024April 25, 2024 by Brian Colvert

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Are you contemplating retirement? Are you wondering when you can retire?

In the most recent episode of The Field Guide Podcast, Brian Colvert, CFP® of Bonfire Financial, dives into the complexities of retirement planning and addresses the question we often get asked… When can I retire? From financial considerations to psychological readiness, Brian offers insights to help you navigate this significant life transition.

Psychological Preparedness:

One of the key factors in determining when to retire is psychological readiness. Many individuals tie their identity to their careers, making the prospect of retirement daunting. Brian emphasizes the importance of having a plan in place to alleviate anxiety and uncertainty. Whether it’s traveling, pursuing hobbies, or spending time with loved ones, having a structured schedule can enhance the retirement experience.

Financial Considerations:

While psychological preparedness is crucial, financial planning is equally important. Brian acknowledges the variability in retirement lifestyles, from extravagant globetrotting to simpler pleasures like hiking and local gatherings. Understanding your current expenses provides a baseline for retirement preparedness. Contrary to the popular notion that retirees spend significantly less, Brian suggests that initial retirement years may involve increased spending due to travel and leisure activities.

The 4 Percent Rule:

To estimate retirement income needs, Brian touches on the 4 percent rule—a widely used guideline in financial planning. By dividing the desired income by 4 percent, one can determine the required investment portfolio. While this rule provides a starting point, Brian emphasizes the need for flexibility and ongoing financial planning.

Beyond the Basics:

Retirement planning extends beyond simple calculations. Brian highlights the importance of accounting for factors like healthcare costs, inflation, and unexpected expenses. Collaborating with a financial advisor ensures a comprehensive strategy tailored to individual needs and goals.

Final Thoughts:

Answering the question of “When can I retire?” requires a blend of financial prudence and lifestyle considerations. While the prospect may seem daunting, proactive planning can pave the way for a fulfilling retirement experience.
If you’re seeking personalized guidance or additional resources, don’t hesitate to reach out to us. Our team is dedicated to helping individuals like you achieve their retirement aspirations.

Remember, retirement is not just about reaching a financial milestone—it’s about crafting a life that reflects your values and passions. Start planning today to embark on a retirement journey that’s as rewarding as it is fulfilling.

Get started with your Financial Plan today!

401k Contributions for Pilots

Posted on January 29, 2024April 30, 2024 by Nick Coleman

The landscape of retirement savings is complex, particularly for United Airlines pilots who face unique choices with their 401k in planning their financial future. The recent introduction of the Market-Based Cash Balance Plan (MBCBP) offers an additional avenue for retirement savings complementing the existing 401k plans.

Today we’ll take an in-depth look at these choices, focusing on how United Airlines pilots can best navigate their 401k contributions in light of the new MBCBP. We will examine contribution limits, potential tax benefits, and the strategic implications of different savings approaches, all designed to assist pilots in making well-informed decisions for their long-term financial well-being.

Should United Airlines Pilots Maximize Their 401k Contributions with the new Market-Based Cash Balance Plan Available?

Many United Airline pilots fund their allowable 401k contribution along with receiving the 17% contribution to their 401k from United.

The most an employee can contribute to their 401k in 2024 is:

$23,000 if under 50 years old
$30,500 if 50 years old or older

United will also contribute to your 401k, whether you are contributing or not. An employee is only limited to contributing the above numbers, however, the 401k has a separate total limit that includes all contributions; both from you and from United. That 401a maximum is called the 401a Limit.

In 2024, the 401(a) Limit is set at:

$69,000 if under 50 years old
$76,500 if 50 years or older

Once that limit is hit, United’s 17% contribution does not stop. It must flow into a different bucket. Previously, the 17% went into the Health Reimbursement Account (HRA), which many pilots did not find beneficial. Many pilots we worked with wanted to reduce the spillover, so more company dollars went into their 401k, rather than spillover. However, the new Market-Based Cash Balance Plan, a retirement plan similar to the 401k, is a much more beneficial account that many pilots are wanting to take advantage of.

Now, pilots want to get as much spillover as possible, so this account gets funded more.

Why is the Market-Based Cash Balance Plan (MBCBP) a good option?

The contributions from United are not taxed in the year of the contribution. They are deferred until you take the money out. You can also roll the funds into an IRA when you retire and manage the account by yourself or have a retirement planner like us manage it for you. Much like the 401k.
It will allow you to save even more for your retirement. Many pilots that want to save more for retirement, or are nearing retirement and want to maximize savings, will find this account to be very useful.
Your money will be invested for you, and aims to have a reasonable return of 5-6% per year.

With that being said, you may decide that you want to maximize what United “spills” into your new retirement account (MBCBP). But how can you do this?

Best way to maximize your savings:

The best way to maximize your savings is by maximizing your employee 401k contribution. If you are 50 years old, you can contribute $30,500 into your 401k. United, at 17%, will contribute up to the total limit of $76,500, meaning they will fund the rest at $46,000. Once United has funded $46,000, you have hit the max. From there, United’s 17% will fund the MBCBP. If you are under 50, your contribution max is $23,000 and total max is $69,000. So United still has a contribution of $46,000 to reach your $69,000 limit/

According to our math, if you maximize your 401k contributions, your 401k will max out once your salary reaches approximately $270,000. 17% of all dollars above that will flow to the MBCBP. For example, if your salary is $370,000, you will receive $17,000 into your MBCBP ($100,000 x 17%). In total, you would have added $93,500.

This is a better option than not contributing to your employee contribution. If you decide not to contribute at all, United will have to contribute up to 17% of your salary up to $345,000 into your 401k before it spills over (See 401(a) Limit). For example, if your salary is $370,000 that means your total retirement additions will only be $62,900.

Why Should You Maximize Your 401k Contribution?

In the past, United Airlines Pilots were hesitant to overfund their 401k’s because they did not want excess funds funding the RHA or the HRA. Going forward, pilots can now have the spillover continually fund a retirement account. The other reason to maximize your 401k is that you will be saving an additional $30,500 per year for retirement (50+), plus you can write it off as a tax deduction if you are funding the traditional 401k.

When we do a quick math calculation, we can see the major impact that saving $30,500 can have just on a 10 year timeline. Let’s say you contribute $30,500 per year, for 10 years, and you earn a reasonable return of 8%. How much money will you have after 10 years? When you include compounding interest, your total would be $441,840. Close to half a million dollars in additional retirement savings in just 10 years!

Which should you choose, the HRA or the MBCBP?

From initial discussions, it looks like pilots will only be allowed to choose one option or the other. Should you choose the HRA or the MBCBP?

HRA:

Benefits:
- Tax-Free reimbursement for most medical, dental, and vision expenses, including copays and premiums
- Good option for paying medical expenses in retirement
Cons:
- Non-portable. Meaning you cannot move this account at any time. It stays at a trust at United
- If you and your spouse pass away without using the entire amount, the balance get reverted back into the trust

MBCBP:

Benefits:
- Can move the account to an IRA at 59 ½
- Contributes and grows tax-free
- Helps you save more for retirement above traditional limits
Cons:
- Investment is controlled by a third-party committee
- Cannot be used until retirement age of 59 ½
- Pay income tax when you use the money

Want to maximize your financial plan?

As a CERTIFIED FINANCIAL PLANNER™, I’ve had the privilege of working with over 50 pilots, just like you, to help them chart a course toward a secure retirement and a prosperous financial future. My specialization in United pilot benefits helps equip me to guide you in maximizing your career earnings and benefits. There are many accounts and benefits that we want to help you get the most out of, before you are forced into retirement by current FAA laws. By working with us, we can help you get on the right track to the retirement and financial future you deserve. Let’s get started today.

2024 United Pilot Plan Updates: Cash Balance Plan

Posted on January 4, 2024April 26, 2024 by Nick Coleman

2024 United Pilot Plan Updates: Understanding the Cash Balance Plan

If you’re a United pilot, the dawn of 2024 likely brings with it an exciting prospect—the new contract set to take effect this year. Among the changes, the introduction of the Market-Based Cash Balance Plan (MBCBP) has piqued the interest of many United pilots. As a CERTIFIED FINANCIAL PLANNER™, I’ve had the privilege of working with over 50 pilots, just like you, to help them chart a course toward a secure retirement and a prosperous financial future. My specialization in United pilot benefits helps equip me to guide you in maximizing your career earnings and benefits.

How the Market-Based Cash Balance Plan works with your current plan

The Market-Based Cash Balance Plan represents an opportunity to enhance your retirement savings, working in conjunction with the Profit Sharing Retirement Account Plan (PRAP). This supplementary retirement savings account is designed for spillover contributions from your 401(k) plan. The question on many pilots’ minds is how the MBCBP operates, how it can be utilized, and whether it offers advantages over the Health Reimbursement Account (HRA).

Understanding the MBCBP involves grasping two crucial limits—the 401(a) Limit and the 415(c) Limit.

The 415(c) Limit sets the total cap on contributions to your 401(k) from both your employee and employer contributions. For individuals under 50, this limit stands at $69,000, while those 50 or older can contribute up to $73,500. Meeting this limit can occur when maximizing your 401(k) contributions, which are:

$23,000 for individuals under 50
$30,500 for those aged 50 or older

The 401(a) Limit, dictated by ERISA regulations, determines the portion of your salary that United considers when contributing to your 401(k). In 2024, this limit is set at $345,000. If your salary exceeds this amount, United’s 17% contribution will spill over into either the HRA or MBCBP. For example, if your salary reaches $445,000—$100,000 over the limit—this excess 17% translates to $17,000 as spillover. Over a decade, this could accumulate to a substantial sum.

Understanding the Market-Based Cash Balance Plan

So, what exactly is a Cash Balance Plan? It serves as a retirement account, much like your 401(k), but with the capacity to hold a more significant sum for retirement than traditional retirement accounts. While a 401(k) is constrained by an annual limit—$69,000 in 2024, for instance—a Cash Balance Plan can theoretically accommodate contributions of up to $300,000 annually. This account operates differently from a 401(k) in that it follows a “Defined Benefit” model, allowing for higher contributions to support specific benefits, such as an annual pension.

The Market-Based Cash Balance Plan is a deferred plan, meaning you don’t pay taxes on contributions or growth within the account. Instead, taxes are levied when you withdraw funds during retirement, aligning with your income tax level at that time. This structure can be advantageous, as it doesn’t increase your taxes while working, potentially leading to lower tax brackets in retirement.

Regarding investment management, Cash Balance Plans prioritize a “reasonable return” within strict ERISA and IRS guidelines to safeguard the defined benefit. As such, pilot investments in the MBCBP aren’t subject to individual choices but rather managed collectively by a committee. Upon retirement, you have the flexibility to roll over the MBCBP into an IRA. This will grant you greater control over investment decisions.

One notable advantage of the Cash Balance Plan is its portability. After retirement, you can transfer the funds to an IRA, allowing for greater flexibility and potential wealth transfer. In contrast, the HRA and RHA remain non-portable and are confined to United’s trust, accessible only for qualified health-related expenses and with limited beneficiary options.

Is a Market-Based Cash Balance Plan Right for You?

So, should you consider using the 2024 United Pilot Cash Balance Plan? If you aspire to save more for retirement, especially as retirement draws nearer, it could be a valuable tool. However, it’s essential to retain some funds for potential health expenses in retirement, considering that healthcare costs can be substantial. Fidelity estimates that a couple retiring in 2021 might spend around $157,000 on medical expenses during retirement.

Additionally, you can maximize your 401(k) contributions further by taking full advantage of your personal contribution limit:

$23,000 for individuals under 50
$30,500 for those aged 50 or older

By doing so, you not only bolster your retirement savings but also may enjoy significant tax benefits. Contributions are tax-deductible, potentially leading to substantial tax savings.

Furthermore, you may consider diversifying your retirement savings by exploring Tax-Free retirement options like the Backdoor Roth IRA Conversion. This strategy can help you build tax-free retirement income while avoiding Required Minimum Distributions (RMDs).

Next Steps

To ensure you’re making the most of your 401(k) and United pilot benefits, consider discussing your retirement goals with a professional. I’ve worked closely with numerous pilots to navigate the complexities of their financial plans, and I’m here to help you secure a successful financial future and retirement.

Let’s start a conversation about your financial goals and explore the strategies that can help set you on the path to financial freedom and a prosperous retirement. Set up a free consultation call today to learn more about how we can help you!

Navigating Retirement Contributions: Demystifying 401(a) and 415(c) Limits

Posted on September 19, 2023April 26, 2024 by Nick Coleman

Retirement planning isn’t just about saving; it’s about mastering the rules of the game. If you’re a high-flyer working for a major airline, you’ve probably heard about the 401(a) and 415(c) limits – but do you truly understand how they can help supercharge your retirement savings? Let’s break down these limits, unravel the intricacies, and set you on the path to maximizing your retirement nest egg.

What is the 401(a) limit?

The 401(a) limit caps the amount of money your employer can contribute to your 401(k), as described by a salary limit. That salary limit for 2024 is $345,000. This means when your employer is contributing to your 401(k), they are going to contribute XX% of your salary up to $345,000 of your salary.

For example, if United contributed 16% of your salary into your 401(k), the most they will add is $55,200 ($345,000 X 16%). If your salary is higher than $345,000, they can no longer contribute to your 401(k), and this is where the money may spill over.

Some more senior pilots may have a salary higher than salary limit. In this case, they will get the maximum amount allowed from their employer. If your salary is under that, you don’t have to worry about that limit. However, both pilots will have to pay attention to the next limit, called the 415(c) limit, which will limit what you and your employer contribute as a total limit.

401(a) Limit: Your Key to More Employer Contributions

The 401(a)(17) compensation limit, nestled within the U.S. Internal Revenue Code, is your golden ticket to getting your employer to pump more money into your 401(k). This limit caps the portion of your earnings that counts when determining contributions to specific retirement plans, including beloved options like 401(k)s and defined benefit pension plans.

Now, the real magic happens when you align your contributions with the 401(a) limit. This strategic move can lead to a larger employer contribution to your 401(k), leaving you with more take-home dollars. The aim is to maximize your 401(k) without hitting the cap too soon or spilling over.

415(c) Limit: The Sibling of 401(a)

But wait, there’s more! The 415(c) limit, or Section 415(c) limit, is another player in this retirement savings game. This provision in the tax code sets the annual ceiling on contributions or benefits allocated to an individual’s retirement account within qualified plans, spanning 401(k)s, 403(b)s, and pensions.

These limits aren’t etched in stone; they evolve yearly to keep up with inflation and economic shifts. For the most current numbers, consult the IRS or your trusted tax advisor when making retirement contributions.

Making Sense of 415(c): Real-Life Scenarios

Let’s dive into real-life scenarios. Imagine you’ve maxed your contribution at $22,500. Your employer can contribute up to $43,500. If your salary is $280,000 and your company matches 16%, that’s a generous $44,800 from your employer. However, there’s a $1,300 spillover due to the 415(c) limit. In this case, you could reduce your contribution to $21,200 and still receive the full $44,800 employer contribution, reaching a total of $66,000.

Now, what if you’re 50 or older and want to hit the max of $73,500, including a $7,500 catch-up contribution?

401(a) at Play: Maximize Your Employer’s Share

Here’s a twist – you can contribute only the catch-up amount to your 401(k) if your employer’s contributions have already filled your account to the max. Say you earn $345,000, and your employer contributes 16%, giving you $55,200. If you’re under 50, you can add $13,200 to reach the $66,000 cap. If you’re 50 or older, it’s an extra $20,700 to hit the $73,500 limit. Fascinatingly, neither scenario requires you to max out your employee limit of $22,500 plus a $7,500 catch-up.

Crunching the Numbers for Your Benefit

To make the most of these limits, a little number-crunching and projection are in order. Consider your salary history and estimate future earnings to create a strategy that maximizes both your contributions and those from your employer.

Why does all this matter? Because it’s your gateway to getting more money into your 401(k), rather than spillover accounts. And the more you get in now, the better your financial future will look in retirement.

Beyond 401(k) – The Backdoor Roth Conversion

But our journey doesn’t end here. For our high-earning clients in the airline industry, we’re here to uncover your financial dreams and set you on the right track. One exciting strategy to explore is the Backdoor Roth Conversion. This allows you and your spouse to stash away $6,500 each per year, or $7,500 each if you’re 50 or older, in addition to your 401(k) contributions. It’s a powerful way to build a pool of tax-free retirement dollars.

In a nutshell

In real-life scenarios, these 401(a) and 415(c) limits offer opportunities for fine-tuning your contributions. By making thoughtful adjustments to your contributions, you can leverage your employer’s contributions and, if you’re 50 or older, take advantage of catch-up contributions. Ultimately, these limits are the building blocks of a more secure financial future in retirement. The more you invest wisely within these boundaries, the more comfortable and stable your retirement years will become. So, remember, it’s not just about accumulating savings; it’s about understanding and utilizing these financial limits to secure your financial well-being in retirement.

What We Can Do for You

As a Certified Financial Planner and Fiduciary Financial Planner, we partner with over 50 pilots just like you, helping them discover their financial goals and chart a course to success. We can help you navigate 401(a) and 415(c) limits. Those who work with advisors or have done so in the past often have at least double the retirement savings of their peers, sometimes even more. Your financial future deserves expert guidance – let us help you soar towards your retirement dreams.

Set up a free consultation call today to learn more about how we can help you!

Colorado Secure Savings Mandate – What you need to know

Posted on May 17, 2022April 26, 2024 by Brian Colvert

What business owners need to know about Colorado Secure Savings Act

In 2020 Colorado passed the Colorado Secure Savings Program. This law mandates that small business owners enroll in a state-run retirement savings plan. The pilot program launched in October 2022 and employers throughout Colorado are now required to comply.

The purpose of this mandate is to increase access to retirement savings for workers in Colorado. The Colorado Secure Savings Act mandates that qualifying employers provide an employer-sponsored individual plan. The cost of this program will be funded through auto payroll deductions.

In general, this seems like it will have positive benefits for employees. However, it may create additional burdens for employers and may in fact limit employees’ options. Here is what small business owners need to know about the Colorado Mandated Small Business Retirement Plan.

Who needs to comply:

The Colorado General Assembly states that you, as an employer, will be required to implement this program if:

You have five or more employees
Have been in business for two or more years
Don’t have an existing qualifying plan

Companies already offering 401ks or other qualified savings plans are not required to use the Colorado Secure Savings Program. The law states that employers with less than 5 employees or who have not yet been in business for 2 years will not be required to participate. However, they will have the option to offer the program to their employees.

What needs to be done:

While there is limited guidance at the moment from the State of Colorado, employers will be required to offer auto-enrollment and facilitate payroll deductions into the program.

Upon enrollment, employees will opt into the default savings rate for Colorado Secure Savings, which is 5% of their gross pay. Beyond this, deferral rates may vary depending on how much you want to save each year. In addition, age, marital status, and income play a role in the amount that employees can contribute.

However, employees will be able to change their contribution amount or opt-out if desired.

As it is written so far, employers will have 14 days to send employees’ contributions to the program administrator. The program oversight will be done by the board of the Colorado Secure Savings Program. The board is currently chaired by the Colorado State Treasurer. This board will be making a process for withholding employees’ wages and remitting withheld amounts into their Colorado Secure Savings account. It’s not yet clear if the program will offer any integrations with payroll providers to facilitate the timely deposit of contributions.

Penalties for noncompliance:

Fines can be costly. For non-compliance, fines will be $100.00 per employee per year and can ratchet up to $5000.00 annually. The compliance period is one year after implementation.

However, they do state they plan to create a grant program to incentivize compliance. Yet no further details have been released. The good news is it’s really easy to comply by setting up a 401k plan or another qualified plan in advance. Keep reading on to find out how.

General Concerns:

There is little to no guarantee of the level of quality or support that will be available to business owners from the state in implementing and managing the Colorado Secure Savings Program. The government has not released any real guidelines. There are some basics, but how is still very undefined.

Further, if a company offers the state-run plan many of their higher income employees will be excluded. Employees with a Modified Adjusted Gross Income of more than $139,000 or $206,000 married filing jointly cannot participate.

As we wait for more details it’s not a bad idea to consider all the various plan options available to you and your company.

State Sponsored vs Employer Sponsored

There are a handful of states that currently have state mandated plans in place. California, Oregon, and New York are a few for instance. State sponsored plans have pros and cons, which business owners should carefully weigh. On one hand, government-mandated plans are generally a cheap solution with few fiduciary implications. On the other, these plans tend to be inflexible, one-size-fits-all. Plus they come with potential government penalties.

State sponsored retirement plans:

Roth IRA Investment structure (after-tax)
The state board selects investments
The plan will “travel with” people if they change jobs or leave the state
Excludes higher income employees
No employer contributions
No federal tax credits for employers
Creates a significant burden for the employer

As an alternative, an employer sponsored 401k or other qualified plans may be a better option than having the state do it for you. A common misconception is that employer sponsored plans are expensive. However, that simply isn’t the case. Many plans are now being tailored for smaller companies. Plus, the IRS gives tax credits to firms with fewer than 100 employees for some ordinary and necessary costs of starting an employer sponsored plan.

Employer Sponsored 401K plans:

Allow an employee to make contributions either before or after-tax, depending on plan options
Wide range of investments at various levels of risk chosen by the employer or by an advisor
Employee may direct their own investments
Higher Annual Salary Deferral Limit
No employee income limits
Allows for employer contributions
Federal tax credits for the employer for start-up and admin costs and employee education

In addition, offering an employer-sponsored plan to your employees may increase your company’s competitiveness in the job market. It could also help you retain valuable staff. Plus, you and other company leaders can participate.

If you work with a payroll services provider, the software can easily and automatically transfer employees’ funds, making the procedure effortless. Additionally, private plans typically come with the support of financial advisors. Moreover, a financial advisor can help regarding plan types and how best to implement them for your business.

Clearly, adding a 401k or other qualified plans to your company’s benefits package has strategic advantages. Yet, by not providing your employees with a retirement plan, you risk having the state impose one.

Do State-Run Plans Even Work?

Time will tell. However, Oregon, the first state to legally mandate a retirement plan, has pretty dismal enrollment numbers. Since its inception in 2018, only 114 thousand workers have enrolled out of a potential of over 1 million total.

Using Oregon again as an example, there are a lot of restrictions. First, the percentage contribution is fixed. Second, the employee’s first $1,000 gets put into a stabilization fund that since its inception has earned 1.52% per annum, or basically 0%, Or less after factoring in inflation. Finally, if and when they have more than $1,000 invested, they must decide between a fund that is a mixture of stocks and bonds and one that is invested entirely with the State Street Equity 500 Index Fund. (03/31/2022)

By comparison, in the private sector, there are multiple low-cost, exchange-traded funds, most of which averaged an annual return of over 10% during the most recent 10 year period. Some would argue that directing employees away from these superior investment products arguably does a disservice to the employees.

Sample Administrative Duties

Further, Oregon has demonstrated what a significant burden the plan can be on employees. Here is a short list of employer duties that Colorado will likely have as well.

Submit an employee census annually
Track eligibility status for all employees
Provide enrollment packets to all employees 30 days after date of hire
Plus, track whether each employee has opted in or out
If an employee doesn’t opt out within 30 days, set up 5% payroll deduction
Manually auto-escalate all employees annually unless they’ve opted out
Repeat auto-enroll process annually for all employees who have opted out
6-month look-back for auto-escalation:
- Track if the employee has been participating for 6 months with no auto-escalation
- Provide 60-day notice if they do not opt-out again
Hold open enrollment
Auto-enroll anybody who hasn’t been participating for at least 1 year

It’s too early to know whether state-run programs work. After all, Saving for retirement is a marathon, not a sprint. As an employer, it is important to weigh all options.

What Are Alternatives to the Colorado Secure Savings Program?

If you do not already have an existing plan, and you are skeptical about a government-mandated plan, you can always make your own employer-sponsored plan. Bonfire Financial has many 401k, Simple IRA, and SEP IRA options. We provide affordable, hassle-free solutions that will reduce the administrative burden.

Colorado Secure Savings vs Retirement Plan with Bonfire Financial

How can my business establish its own retirement plan?

Above all, retirement plans don’t have to be expensive or difficult to manage. In light of Colorado’s rollout of the Secure Savings Plan, we are offering small business owners and employers a free, no-obligation call with a CERTIFIED FINANCIAL PLANNER™ to help answer all your questions. We can help you create a better, more efficient retirement plan that is tailored to you and your employee’s specific needs. We are local in Colorado Springs and are here to help with all your retirement plan needs.

10 Mistakes to avoid with your Roth IRA

Posted on May 5, 2022April 26, 2024 by Nick Coleman

Roth IRA Mistakes

An individual retirement account (IRA), specifically a Roth IRA, is a great option to save for retirement. However, there are a handful of common Roth IRA mistakes people make.

One of the great things about a Roth IRA is that while contributions to a Roth IRA are not tax-deductible when you make them, the distributions can grow tax-free. Unlike a traditional IRA which is tax-deductible, you’ll have to pay taxes on them at your income tax rate.

Currently (as of 2024), a Roth IRA contribution allows investors to save up to $7,000 an additional $1,000 if over 50 years into an account that will forever be tax-free. That means if you started a Roth IRA when you were 18 years old, and you’re now 55, every single dollar including the gains are tax-free. Peter Thiel, a hedge fund manager, turned his Roth IRA into a 6 Billion Dollar tax-free account. Maybe you won’t end up with that much in a Roth IRA, but any amount that is not taxed by Uncle Sam, the better.

Many pre-retirees want to find more ways to save for retirement. They also want to make sure they are setting themselves up for a better tax situation when they start taking money out of their accounts. A Roth IRA allows married couples over 50, to add an additional $16,000 ($7,000 each) per year, helping them build a tax-free nest egg.

However, there are several common mistakes we see that cause people major tax issues or nullify their contributions. Below are the most common mistakes we find and how to avoid them

Mistake #1 – Contributing When You Don’t Qualify

The government wants people to save, however, they don’t want them to be able to save too much. As such, you can earn too much to contribute to a Roth IRA. Whether you’re eligible is determined by your modified adjusted gross income. Plus the income limits for Roth IRAs are adjusted periodically by the IRS. As such Roth IRA mistakes can be made.

Find the current Roth IRA Contribution Limits can be found here.

If you make contributions when you don’t qualify, it’s considered an excess contribution. The IRS will charge a tax penalty on the excess amount for each year it stays in your account.

How to avoid it:

If you’re close to the income limits, one way to avoid the extra tax penalty is to wait until you’re about to file your taxes. Then you can see how much if anything you can contribute. You have until the day your taxes are due to fund a Roth IRA. This way, you avoid making the mistake of contributing more than the allowable maximum. Plus, helps to avoid paying unexpected penalties.

Mistake #2 – Funding more than one Roth IRA

Let’s say you fund a Roth IRA with Bonfire Financial, and also open another Roth IRA at Vanguard, for example, you cannot contribute $7,000 to each Roth IRA. If you contribute more than you’re allowed to your Roth IRA, you’ll face the same excise tax penalties on those extra funds.

How to avoid it:

To avoid this problem, be sure to watch and manage the total amount of contributions in all of your Roth IRA accounts. If you do accidentally put in too much, you can make a withdrawal without penalty as long as it is before the tax filing deadline. You also have to withdraw any interest earned.

Mistake #3 – Not Funding your spouse’s Roth IRA

While your contributions to a Roth IRA are limited by the amount of money you’ve earned in a given year, there is an exception. Your spouse! Even if your spouse has no earned income, they can still contribute to their own Roth IRA via the Spousal Roth IRA. You must be legally married and file a joint return to make this work.

How to avoid it:

By using a Spousal IRA, you can double up on your Roth IRA contributions. You can save an extra $8,000 per year in tax-free dollars if over 50 years old.

Keep in mind that IRAs are individual accounts. As such, a Spousal Roth IRA is not a joint account. Rather, you each have your own IRA—but just one spouse funds them both.

Mistake #4 – Too large of a Roth Conversion

Roth conversions are a good tool to use to make your future earnings tax-free and avoid RMDs in the future. How these conversions work is by moving pre-existing funds in your traditional IRA or traditional 401K into a Roth or Roth 401k. The amount of money that is converted or moved from one account to the other will be taxable at whatever your current income tax bracket is.

One problem that can happen is that if you are close to the next income bracket and you convert funds over to a Roth, some of the conversion could be taxed at a higher rate. It pushes you into the next income bracket. These conversions cannot be reversed. So, if you are not working with an advisor and your tax professional you can inadvertently pay more taxes than you need to.

How to avoid it:

If you have large IRAs or 401k and would like to convert into a Roth, it is best to watch your income brackets and convert an amount of money that would fill your current income tax bracket but not spill over into the next. It is best to use this strategy over multiple years.

Mistake #5 – Not doing a Backdoor Roth

Many of our clients have incomes that are above or well above the Roth IRA income phaseout. Yet they and their spouses are funding their Roth IRA’s fully each year. How?

By using a strategy called the Backdoor Roth Conversion. A Backdoor Roth Conversion is done by funding an empty IRA then immediately converting the IRA dollars into the Roth IRA. In this way, you are funding a traditional IRA and not-deducting from your income, also known as a nondeductible IRA contribution, and then converting into the Roth IRA, which is allowed regardless of income. In this strategy, you indirectly fund the Roth IRA and can continue to do this every year going forward.

How to avoid it:

If you make too much money to contribute directly to a Roth IRA, consider doing a Backdoor Roth. There are some drawbacks to converting a traditional IRA to a Roth IRA. Since the money you put into your traditional IRA was pre-tax, you’ll need to pay income tax on it when you do the conversion. It’s possible that this additional income could even bump you up into a higher tax bracket. We highly recommend talking to a CERTIFIED FINANCIAL PLANNER™ about implementing this strategy.

Mistake #6 – Doing a Backdoor Roth with Money in an IRA

One mistake we often see is someone funding a backdoor Roth IRA while concurrently having pre-tax dollars in other IRA accounts. The reason this is a problem is that the IRS looks at all accounts. And due to the “Pro-rata Rule” treats them as one. You cannot simply just choose to move after-tax dollars into a Roth IRA.

You have to calculate the amount of money that can be moved into a Roth without paying taxes by dividing the amount of after-tax dollars by the total amount of money in all your IRA accounts.

How to avoid it:

A way to avoid this common pitfall is to account for all IRAs. (SEP IRAs, Simple IRAs, and or traditional IRAs)This will help know whether you can contribute without triggering the Pro-rata rule. You could also convert all pre-tax dollars at once. Or, another option would be to roll your IRA money into a 401k so that you no longer have any money in an IRA.

Mistake #7 -Not properly investing the money

One common mistake we see investors make is that they believe the Roth IRA is an investment when it is simply an account. Just because you contribute to a Roth IRA doesn’t mean it is invested automatically.

It is not enough just to open an account. You have to go into the account and select investments and manage them. If you just contribute to a Roth IRA without selecting an investment in the account, it could be just sitting in cash!

How to avoid it:

Invest the money in your Roth IRA. If you are unsure of a good investment strategy, schedule a meeting with one of our CERTIFIED FINANCIAL PLANNER™ professionals. We can help make sure your Roth IRA is invested correctly for you based on your goals, time horizon, and risk tolerance.

Mistake #8 -Not optimizing your Roth Dollars

Oftentimes, we see Roth IRA investors using allocations that are very conservative. Or they match other allocations in their 401(k). This is a massive oversight and not planning for a proper tax allocation strategy. A Roth IRA should be managed more aggressively than your other accounts so that you can take full advantage of the tax-free benefit.

How to avoid it:

Leave the conservative allocation to the after-tax and tax-deferred accounts. A Roth IRA should be as aggressive as you are willing and capable of doing. One advantage of IRAs over 401k plans is that, while most 401k plans have limited investment options, IRAs offer the opportunity to put your money in many types of stocks and other investments.

Mistake #9 – Forgetting to name Beneficiaries

It’s important to name a primary and contingent beneficiary for your IRA accounts. Otherwise, if something happens to you, your estate will have to go through probate. And that can take more time, cost more money, and cause a lot of inconveniences.

How to avoid it:

Name your beneficiaries and be sure to review them periodically and make any changes or updates. This is especially important in the case of divorce. We see a lot of issues arise because a divorce decree won’t prevent a former spouse from getting your assets if he or she is still listed as a beneficiary on those assets.

Mistake #10 -Not having a CFP® Manage your investment and tax strategy

There are many nuances to opening and maintaining a Roth IRA. The investments, the tax strategies, and the timing of contributions can all make or break your account’s tax-free status. This potentially could cost you additional taxes and penalties.

How to avoid it

Work with a CERTIFIED FINANCIAL PLANNER™ to help you set up, and maintain your Roth IRA. They can help plan for an effective retirement and tax strategy. Having a professional help you with your retirement accounts and other complicated retirement plan strategies can potentially help you avoid expensive Roth IRA mistakes.

To Sum it Up- Don’t make these Common Roth IRA Mistakes

Roth IRAs can provide a lot of great retirement benefits, but they can also be complicated. There are a lot of common mistakes with a Roth IRA. It is important to pay attention to all the regulations and rules to help you avoid these common mistakes.

Have questions about your Roth IRA? Give us a call! We are local in Colorado Springs but help clients all over the nation. We are happy to help.