Retirement savers understand the importance of being proactive.
Having healthy retirement savings can help you live comfortably in
your later years. As stewards of our clients' wealth, we take great
satisfaction in helping them prepare for retirement. We also enjoy
assisting parents and grandparents who wish to contribute to their
loved ones' futures by properly gifting funds to a retirement account,
provided the recipient has earned income and qualifies. Funding
retirement accounts at younger ages can significantly improve the
chances of enjoying a comfortable financial situation during
retirement.
You can contribute to a 2025 IRA until the tax filing deadline of April 15, 2026. The annual contribution limit for 2025 is
$7,000, or $8,000 if you are age 50 or older. Your ability to use a Roth IRA contribution can be limited based on your filing
status and income (see box in this report). Now is a good time to consider making your 2025 retirement contributions.
Traditional IRAs
A traditional IRA (Individual Retirement Account) is a way
in which individuals can save for retirement and receive tax
advantages. Traditional IRAs come in two varieties:
deductible and nondeductible. Contributions to a
traditional IRA may be fully or partially deductible,
depending on your circumstances (i.e., taxpayer's income,
tax-filing status and other factors) and generally, amounts
in a traditional IRA (including earnings and gains) are not
taxed until distribution.
A clear advantage of traditional IRA accounts is the benefit
of deferring taxes on all dividends, interest and capital
gains earned inside the IRA account and the potential for
annual tax-free compounding. This may allow an IRA to
have a faster growth rate than a taxable account.
Roth IRA
A Roth IRA is an IRA that is subject to many of the same
rules that apply to a traditional IRA with some major
exceptions. Unlike traditional IRAs which can be tax
deducted, you cannot deduct contributions to a Roth IRA.
Some Roth IRA advantages include:
• If you satisfy the requirements, qualified distributions
can be tax-free.
• You can leave funds in your Roth IRA for your entire
lifetime.
• Beneficiaries inherit your Roth IRAs tax-free, if account
requirements have been satisfied.
Many investors know and understand that the largest
benefit of the Roth IRA is its tax-free withdrawal of
contributions, interest and earnings in retirement, but Roth
IRAs can also be a powerful part of good estate planning.
ROTH and Traditional IRAs -
Strategies for Building Your Retirement in 2025
For complete rules on Individual Retirement Accounts (IRAs), please visit www.irs.gov Publication 590a or call us to
discuss this and all your retirement strategies. In the meantime, here is some information that you may find helpful.
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Anthony (Tony) Engrassia, ChFC, LUTCF, NSSA®
Certified Financial Fiduciary®
Spousal IRA
If your spouse does not work, they can still fund a spousal
traditional or Roth IRA. This allows non-wage-earning
spouses to contribute to their own traditional or Roth IRA,
provided the other spouse is working and the couple files a
joint federal income tax return. If the working spouse is
covered by a retirement plan at work, deductibility of
contributions to a spousal traditional IRA would be phased
out at higher incomes. Eligible married spouses can each
contribute up to the contribution limit each year to their
respective IRAs (spousal IRAs are also eligible for a $1,000
catch-up contribution for those 50 and older). To discuss
spousal IRA strategies, call us.
Custodial Roth IRA
Starting retirement savings early can allow the potential
advantage of growing money in a tax efficient account over
a long period of time. Many children work before age 18.
Earned income makes them eligible to contribute to a Roth
IRA, which can be a smart move for teenagers. This can also
provide an excellent opportunity to teach or reinforce the
importance of saving money.
Some of the rules regarding custodial Roth IRAs are:
• To be eligible to open a custodial Roth IRA, the child
must meet all the same requirements as an adult. The
minor must have earned income and contributions are
limited to the lesser of total earned income for the year
and the current maximum set by law, which for 2025 is
$7,000.
• Adjusted gross income for the child must be below the
thresholds above which Roth IRAs are not allowed.
• The Roth IRA must be managed for the benefit of the
minor child.
• As the custodian, you make the decisions on investment
choices—as well as decisions on if, why, and when the
money might be withdrawn—until your child reaches
“adulthood,” defined by age (usually between 18 and
21, depending on your state of residence). Once they
reach that age, the account will then need to be re-
registered in their name and it becomes an ordinary
Roth IRA.
If you are the parent of a child who has earned income, a
Custodial IRA can be a great way to teach the value of
saving and investing. Besides getting a head start on saving,
your child may be able to use the funds for college
expenses—or even to buy a first home.
There are several ways to fund a Custodial Roth. For
example, you can potentially use your annual ability to give
gifts to children or grandchildren to make this happen. If
your child or grandchild is earning money, call us to discuss
options for setting up a Custodial Roth.
“Backdoor” Roth IRA
The traditional contribution ("front door") for Roth IRAs is
currently not available for higher income earners. Married
couples filing jointly earning $246,000 or more and single
filers earning $165,000 or more in 2025 are still fully
excluded from contributing directly to Roth IRAs.
Even though higher earners are ineligible to contribute to
a Roth IRA, in 2010, Congress changed the rules and since
then anyone can convert a traditional IRA to a Roth IRA. A
Backdoor Roth IRA is a strategy for some higher income
earners to participate in Roth IRAs. It is a strategy of
contributing money into a traditional IRA and then rolling
that into a Roth IRA, getting all the benefits. While this
strategy sounds simple, there are several rules that you
must know and follow to make sure you do not incur
unintended tax consequences. This is where working with a
knowledgeable financial or tax professional can provide
guidance and value.
How Does the Backdoor
Roth IRA Conversion Work?
The Backdoor Roth conversion can consist of two steps:
1) You make a nondeductible contribution to your
traditional IRA.
2) Then, after consulting with your financial or tax
professional, you convert this IRA into a Roth IRA.
There is one big caveat: this strategy may work best tax-
wise for people who do not already have money in
traditional IRAs. That is because in conversions, earnings
and previously untaxed contributions in traditional IRAs are
taxed—and that tax is figured based on all your traditional
IRAs, even ones you are not converting. (Please read the
section on the Pro Rata Rule.)
For an investor who does not already hold any traditional
IRAs, creating one and then quickly converting it into a Roth
IRA may incur little or no tax, because after a short holding
period there is likely to be little or no appreciation or
interest earned in the account. However, if you already
have money in traditional deductible IRAs, you could face a
far higher tax bill on the conversion (again, this is covered
later in the section on the Pro Rata Rule).
If you choose to attempt a backdoor Roth IRA conversion,
please consult a qualified tax planner prior to doing so as
the rules for Roth conversions can be complicated.
Example of a Backdoor Roth IRA
Jill, a high-income earner, decides on January 2nd to put
$7,000 into a traditional IRA. Jill's income is too high to be
able to deduct these contributions from her taxes. After
consulting with a financial professional or tax advisor, she
has no other IRAs and then converts the traditional IRAs to
Roth IRAs completely tax-free. Her income is too high to
make a direct contribution into a Roth IRA, but there is no
income limit on conversions. Since Jill could not deduct the
contribution anyway, she might as well get the advantage
of never paying taxes on that money again available
through the Roth IRA.
Beware of the Pro Rata Rule
for Roth Conversions
The Pro Rata rule for Roth conversions states that if you
have any other deductible IRAs (i.e., a previous 401k that
you have rolled over), the conversion of any contributions
becomes a taxable event that you will need to pay taxes on
upfront.
The Pro Rata rule for Roth conversions determines whether
your conversion will be taxable. For taxation purposes, the
IRS will look at your entire IRA holdings (even if they are in
different accounts), not just the traditional IRA you are
converting to a Roth IRA and will determine what your tax
bill will be based upon a ratio of IRA assets that have already
been taxed to those IRA assets in total.
The IRS determines the tax on this conversion based on the
value of all your IRA assets. For example, Sam, a high-
income earner, already has $93,000 in an IRA account, all of
which has never been taxed. He decides on January 2nd to
put $7,000 into a new traditional IRA. The next day he
converts the new traditional non-deductible IRA to a Roth
IRA. Sam’s income is too high to make a direct contribution
into a Roth IRA, but there is no income limit on conversions.
He has $93,000 in other IRAs (previously ALL non-taxed), so
his total IRA assets are now $100,000. When he converts
$7,000 to a Roth IRA, the IRS pro-rates his tax basis on the
previous taxation of his total IRA assets, therefore making
this conversion 93% taxable ($93,000/100,000 = 93%).
If you plan on using this backdoor IRA strategy, you want
to be clear as to whether you have any other IRAs. As you
can see, this can be a confusing area, and this is where we
can help. If you are a high-income-earner we would be
happy to review your situation to determine if this strategy
is in your best interest. Also, please remember that your
spouse’s IRA is separate from yours.
Am I a Candidate for a Backdoor Roth IRA?
Backdoor Roth IRAs can be appropriate for investors who:
• Only have retirement accounts through their jobs (i.e.,
401k's) and want to increase their retirement savings in
Jill's Backdoor Roth IRA Conversion
(without Additional IRAs)
Contribution to
non-deductible
traditional IRA
Convert to Roth
IRA
Income Subject to
Taxation
$7,000
$7,000
$0
This is a hypothetical example and is not representative of any specific
investment. Your results may vary.
Sam's Backdoor Roth IRA Conversion
Prior Non-Taxed
Balance in All
IRAs
Contribution to
Non-deductible
traditional IRA
Convert
to Roth
IRA
Income
Subject to
Taxation
$93,000
$7,000
$7,000
$6,510
This is a hypothetical example and is not representative of any specific
investment. Your results may vary.
tax-advantaged accounts, but whose income is too high
to qualify for standard Roth IRA contributions; and
• Have the time and ability to wait for five years or until
they are 59½, whichever is later, to avoid the 10% penalty
on early withdrawals.
A Backdoor Roth IRA is probably not recommended if you:
• Do not want to contribute more than the maximum
retirement limit through your workplace retirement
account.
• Already have money in a traditional IRA and because of
the Pro Rata rule may end up in a non-tax advantageous
position when converting to a Backdoor Roth IRA.
• Plan or expect to withdraw the funds in the Roth IRA
within the first five years of opening it. A Backdoor Roth
is considered a conversion and not a contribution.
Therefore, the funds may incur a 10% penalty if
withdrawn within five years no matter your age.
• Are in a high tax bracket now and expect to be in a lower
tax bracket in the future.
• Plan to relocate to a lower or no income tax state.
Note: While Backdoor Roth IRAs can be beneficial to
many investors, they are not for everyone. They come
with their limitations and complications. There are
precautions that need to be taken to reap the full benefits
of any financial decision. Please consult and review your
situation with a qualified professional prior to choosing
to use this strategy.
Conclusion
To further discuss funding your retirement plans, or to
schedule a beneficiary review, please call us. This is an area
where a highly informed financial professional can help you
make an educated and calculated decision. As with all tax
sensitive decisions, you should always consult with your
financial and tax professional to help avoid tax
ramifications.
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Financial Planning and Advisory Services are offered through Prosperity Capital Advisors (“PCA”), an SEC registered investment advisor. Registration as an investment advisor does not imply a certain level of skill of training. Wealth Management
Strategies and PCA are separate, non-affiliated entities. PCA does not provide tax or legal advice.
Source: www.irs.gov. Contents Provided by The Academy of Preferred Financial Advisors, Inc.
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