While many provisions of SECURE (Securing a Strong Retirement Act of 2019) got wide-ranging press attention, especially the death of the stretch IRA and increase in the required minimum distribution age to 72, the provision that allows traditional IRA owners to continue making contributions after age 72 got less fanfare.
Before passage of the SECURE Act, investors at RMD age (then age 70 ½) were not allowed to make contributions to their traditional IRAs. In contrast, Roth IRA contributions have been allowed at any age, as long as the contributor or his or her spouse don’t exceed income limits.
The SECURE Act’s “delayed age for first-time RMDs and the lifting of the age requirement for traditional IRA contributions were both nods to the fact that Americans are working longer than they once did,” Christine Benz is Morningstar's director of personal finance said in a new blog.
Twice as many people age of 65 or older were working in 2019 than were on the job in 1985, according to Bureau of Labor Statistics data. And hundreds of thousands of Americans who retired during the pandemic are now re-entering the labor market in their 60s, either on a part-time or full-time basis.
So who does contributing to a traditional IRA instead of a Roth IRA later in life benefit?
While a “Roth IRAs or company retirement plans will tend to be better receptacles for additional contributions from older workers, a traditional IRA may be a fit in a handful of situations,” Benz said.
“The key one is for the older worker who is playing catchup on retirement savings: The contributor can deduct the traditional IRA contribution on her taxes,” Benz said.
When the contribution eventually comes out of the IRA, taxes will be due, “but if the contributor expects to be in a lower tax bracket at the time of the withdrawal, taking the tax break while working will have been worth it,” she added.
If clients are eligible and are not doing qualified charitable distributions, “absolutely yes” I consider traditional IRAs,” Marianela Collado, a senior financial advisor with Tobias Financial Advisors in Plantation, Fla, said.
In these instances, the investor can take advantage of the “backdoor Roth IRA” maneuver by funding the traditional IRA and then converting it to a Roth IRA.
“But there’s a significant caveat in that the pro rata rule affects the taxation of the conversion, and many older adults have significant traditional IRA assets. Converting the funds will trigger a tax bill in that instance,” Benz noted.
Catherine Valega, founder of Green Bee Advisory in Winchester, MA, said while some of her working clients can take advantage of traditional IRA contributions after RMD age, “the conversation is more nuanced now around current and future tax rates – both for themselves and whoever may be inheriting funds.”
That’s because “taxable investment accounts still receive step-up basis if inherited at death,” Valega noted.
There are, of course, other considerations before recommending traditional IRA contributions to clients RMD age.
Contributors or their spouses need to have earned income from paid work in the year for which they make the contribution and it must be at least equal to or above the amount of the contribution.
Spousal income also counts, Benz noted.
“Even if you personally didn’t have any earned income, if your 73-year-old spouse earned $15,000 from a consulting gig in a given year and wanted to make $7,000 IRA contributions for each of you, that would be perfectly allowable,” Benz said.
Income from a job, net earnings from self-employment, and disability benefits received prior to minimum retirement age all count as earned income, she said.
Income from other common sources such as Social Security, annuity payments, portfolio income, pension income, RMDs and rental property income do not count toward earned income.
There are also income limits that can prevent wealthier investors of any age from making IRA contributions.
“The contribution limits for traditional IRA contributions that you can deduct on your tax return are the most stringent; Roth IRA contributions are allowable at a higher income limit. Anyone can make a traditional nondeductible IRA contribution, regardless of income or age. Those contributions could then be converted to Roth for a “backdoor Roth IRA.”
However, the backdoor maneuver will trigger taxes if retirees have significant traditional IRA assets that have never been taxed, Benz said.
There is also a significant added benefit to using Roth IRAs, since contributions made later in life can grow beyond RMD age. “Because they’re not subject to RMDs, Roth IRA contributions are a solid choice for earners who are mainly saving to leave assets behind for their heirs and won’t expect to spend the money during their own lifetimes; the tax benefits are stretched out over a much longer time frame,” Benz said.
“Roth IRAs can be the ideal platform if they clients are eligible. I would look at this strategy as more of a generational wealth transfer strategy because the goal is that they would not draw from it as the Roth doesn't have RMDs,” Collado added.
There are similar benefits for making additional contributions to company retirement plans like 401(k)s at RMD age. “Provided the older worker has earned income, she can continue to make contributions and won’t need to take RMDs as long as she is employed. Moreover, income limits don’t apply to company-retirement plan contributions, in contrast with IRAs,” Benz concluded.