Professional Financial Planning (a Real-Life Story)

Categories : Financial, News
May 27, 2021

Sometimes a Certified Financial Planner® (CFP®) can provide the frosting on the cake of your personal financial planning. Accountants, attorneys, other tax preparers, stockbrokers, and insurance agents all fulfill necessary functions. But for some important retirement decisions, more is better. Recently, we had an interesting client case involving a 1-time income windfall and its consequences on Roth IRA contributions. We’ll set the table with some basic background.

  • Married couple, both contributing monthly to IRAs; one to a deductible Traditional IRA, the other to a tax-free, non-deductible, Roth IRA. Neither makes maximum annual contributions
  • During 2020, our clients sold an asset at a significant gain
  • That gain elevated their joint income above the annual limit to make Roth contributions
  • Since Roth contributions had already been made, a correction was necessary

In reviewing the case, we saw that Roth contributions had been a steady $150/month, and had been at that level for years. Therefore, $1,800 of 2020 Roth contributions were disallowed. Since contributions made before Tax Day can be for the prior year, we could reclassify those early 2020 funds as 2019 contributions. That represents Part 1 of the correction.

Here’s where it got creative. Remember what the actual Tax Due Date was in 2020 (for 2019 Returns)? COVID-19 response legislation made April 15 irrelevant, instead postponing the date for filing, paying, and contributing, to July 15, 2020.

The client’s 2019 Roth contributions actually made in 2019 were only $1,800, so we reclassified the first 7 (January through July, rather than 4) contributions made in 2020 back to 2019 contributions. That still kept the client below the $6,000 maximum for 2019.

While the sum of money may seem insignificant because we were able to preserve the funds in the Roth IRA when the funds are eventually withdrawn, the gains will not be taxable. Further, there will not be Required Minimum Distributions (RMDs) on that amount, plus growth. The penalty for failure to remove disallowed Roth contributions is 6% for every year the problem goes uncorrected.

The remaining five months of 2020 Roth contributions (August through December) in the account had to be moved out immediately. That represents Part 2 of the correction. For that, we use a process called a “Back-Door Roth IRA Contribution,” which allows contributions to end up in the Roth, after a couple of legal transactions have been completed.

First, the remaining money ($750.00) was moved to a Traditional IRA, with no deduction taken. Next, we converted those funds back to the Roth IRA, tax-free. Problem solved; the entire $1,800.00 remains in the Roth IRA. The main advantage of keeping the money in the Roth is the absence of later Required Minimum Distributions.

Perspective from a Certified Financial Planner® often makes a situation better. Details are constantly changing in the Retirement Account arena. We remain current in order to assist our clients in staying on course toward financial independence.

Remember that Van Wie Financial is not a tax preparer, and does not render tax advice. What we do well is Tax Planning, which is a no-extra-cost part of our comprehensive personal financial planning service. Does your financial advisor do that? Give us a call.

Van Wie Financial is fee-only. For a reason.