In my last Doctor Dilemma, How Should You Allocate Savings?, I discussed a different kind of investment strategy: taxation of withdrawals. Because we recommend allocating ~1/3 of investable assets to Roth accounts, we are regularly asked how that is possible for a high-income professional. As with other successful strategies, you must plan carefully, be flexible, and monitor your progress.
Here are some ideas to help you build Roth account balances to help get to 1/3 of your savings:
- Every couple should be contributing the maximum (now $5,500) to backdoor Roth IRAs annually.
- Even if you have significant pre-tax IRAs and nowhere to move them, I think you should go ahead and pay the pro-rata taxes. Remember, you are only pre-paying taxes you’ll have to pay later, while increasing the length of time for tax-free Roth growth.
- Consider dividing contributions between Roth and pre-tax when your employer accounts allow. This can be 1/3 to 1/2 in your Roth and the rest in pre-tax. Your CPA can help you plan to contribute enough pre-tax to stay out of the top tax bracket (if possible).
- When you change jobs, roll part of your employer account into a Roth IRA. Again, tax planning with your CPA will be very useful.
- During bear markets (sustained drops in the market of at least 20%) and corrections (drops of 10% – 20% over relatively short periods), convert as much as possible to a Roth IRA and change your work allocation to 100% Roth.
- Finally, don’t forget to make Roth conversions between your retirement date and starting RMD’s.
Having a reasonable allocation to these three areas during retirement will allow you to draw from a combination of accounts and control your income tax bracket post-employment. Keeping track of your progress toward the division during the years leading up to retirement will help you make decisions about allocating extra savings and will help you move toward the Roth when opportunities arise.
At least annually, we compare the balances in each of these tax pails so clients can track progress. They may never reach a 3-way division, but they at least will are of their tax diversification when approaching retirement. Having this goal will motivate you to think twice about the standard advice of allocating all money possible to pre-tax accounts before moving on to Roth and brokerage.
After retirement (and even before), take aggressive advantage of market drops with Roth conversions. This will help reduce your RMDs at age 70.5 and increase the balance of tax-free assets you can pass along to your heirs at death. Because Roth IRAs are not subject to RMDs during the lifetime of the owner, you’ll have the advantage of withdrawing funds only when necessary, leaving the balance to continue to grow tax-free during your lifetime. In addition, while your heirs will be required to distribute inherited Roth IRAs over their lifetimes, the accounts will remain untaxed until they are emptied.