Archives for April 2022

The official IRA contribution deadline for Tax Year 2021 is April 15th, 2022. However, I choose to use April 15th as the informal deadline for my same-year IRA contributions (Tax Year 2022). By around April 1st, I have usually finished filing my income taxes and thus have handled any expected tax bills. I also have the first quarter of dividends arrive in my brokerage accounts, so I also have funds ready to re-invest. The optimal time would actually be make my contributions on January 1st, but sometimes we just have to settle for “good enough”.

If your Modified Adjusted Gross Income (MAGI) exceeds the limits for a direct Roth IRA contribution ($144,000 for singles and $214,000 for married filing joint for tax year 2022), you may still be eligible for the “Backdoor” Roth IRA. Christine Benz of Morningstar has a excellent summary of Backdoor Roth IRA concerns.

A backdoor Roth is simple enough and should be tax-free in many cases. An investor who earns too much to make a direct Roth IRA contribution simply opens a traditional nondeductible IRA–available to investors regardless of income level. Shortly thereafter–and here’s where the backdoor part comes in–he converts it to a Roth IRA, another move unrestricted by income limits. Assuming he has no other IRA assets, the only taxes due on the conversion would be any appreciation in the investments since he opened the account. That taxable amount should be limited, assuming he converts the money promptly and/or leaves the money in cash until the conversion is finalized.

Here’s my even-shorter version of the tips:

• First, check if you have other pre-tax traditional IRA assets such as a rollover IRA. Converting to a Roth IRA may subject these assets to taxes on a pro-rated basis.
• Get rid of these pre-tax IRAs, if possible, by rolling them into an employer 401(k), 403(b), or 457 plan instead. Self-employed business owners can also roll into a Solo 401k.
• Contribute and then convert to Roth quickly. Make the non-deductible Traditional IRA contribution, invest for a day or two in cash, and then quickly convert to Roth. The IRS has clarified that no waiting period is required, making it better to do it right away to avoid any tax complications.
• Repeat at the beginning of every year. Just keep doing it every year, as soon as you can, and build up that precious Roth IRA balance that can grow tax-free forever with no required minimum distributions. Ignore news about the option “maybe” going away until it actually goes away.

Here’s our simple three-day process at Vanguard.

Day one: Make non-deductible contribution to a Traditional IRA account. You could fund in various ways, I exchanged from funds within my Vanguard taxable brokerage account. Just put it in Vanguard Federal Money Market temporarily.

Day two: Go to “Balances & Holdings” page and find the “Convert to Roth IRA” link. Complete required steps.

Day three: Your traditional IRA balance is now $0. Invest the funds that are now in your Roth IRA. In this case, I would have a taxable gain of just $0.03, which simply rounds to zero.

Note: There is still some debate about how much time should pass between the non-deductible Traditional IRA contribution and the Roth conversion. Some people believe that the 2017 Tax Cuts and Jobs Act (TCJA) officially signaled acceptance of this move. Others still want you to wait either for a monthly statement or even a full year in between the steps. I’m not a tax attorney and this is not tax advice. This is just what I did and I don’t lose any sleep over it.

The WSJ article Why Target-Date Funds Might Be Inappropriate for Most Investors (free gift article) discusses new research using “deep learning” artificial intelligence to find the optimal asset allocation over time. There are several interesting insights that also agree with common sense. For example, one size doesn’t fit all. Wealthier investors can withstand the volatility from holding a much higher stock allocation, whereas lower net worth investors need to be more conservative to avoid a hitting zero due to a bad sequence of returns.

Here is how the optimal glide path for the average investor differs between Deep Learning analysis vs. actual Target Date Funds:

Though the primary insight of this modeling is that one size doesn’t fit all, the research did reach one conclusion that does apply to all of us on average: The typical glide path used by target-date funds is too conservative starting at the age of 50. In contrast to an equity exposure level that drops to 50% by retirement age and to as low as 30% during retirement, the average recommended equity exposure in the researchers’ model never falls below 60%.

While I don’t know the details regarding the underlying assumptions of this research, the red AI line caught my eye because I also don’t plan on going below about 60% stocks ever in my lifetime. My reasoning is that I am going for a “perpetual withdrawal rate” scenario where my I just live off a base of growing dividends and interest. (I’m not talking about owning only extreme high-yield products like closed-end ETFs, junk bonds, and leveraged REITs). After reaching the “safe withdrawal rate” number that is based on a very high likelihood of not dying with zero, I wanted even more margin of safety. It can be counterintuitive, but over the long run owning businesses can be “safer” than just own a big bag of cash that is constantly exposed to inflation risk.