A Spousal IRA and a Backdoor Roth IRA Contribution are two additional ways that Investopedia recommends as ways to reduce your tax burden and accumulate more tax-free retirement assets, as reported in the article “2 Ways to Reduce Taxes and Save More for Retirement.”
Spousal IRA. Under the usual situations, a person who wants to contribute to an IRA has to earn income. However, there’s an exception, if you’re a non-working spouse. Your working spouse can establish a “spousal IRA” on your behalf. With a spousal IRA, the working spouse can contribute up to $5,500 on an annual basis to the spousal IRA (or $6,500 if the nonworking spouse is over the age of 50), in addition to their contributions in their own retirement accounts. A married couple must file a joint tax return to qualify.
It’s important to consider whether the spousal IRA should be a traditional IRA or Roth IRA. With a traditional IRA, you’re able to deduct the contributions to the spousal IRA from your income, which will decrease your taxes. You then pay taxes when you withdraw money out of your account during retirement (and when you are presumably in a lower tax bracket). With a Roth IRA, you pay taxes prior to making the contributions, so you don’t get an up-front deduction on your income, but you’re able to make tax-free withdrawals from your account once you reach 59½ and have had your account open for a minimum of five years. You can withdraw your contributions from your Roth IRA whenever you want. It’s only when you withdraw the earnings or interest your account has earned, that you must reach the age and five-year account establishment requirements.
If the working spouse earns more than $199,000, direct contributions into a Roth IRA for his or her spouse are not allowed, so a traditional IRA is the only option (but see the backdoor option below). If the working spouse has access to a 401(k) plan at work, contributions to traditional IRA accounts are still allowable, but the working spouse can’t take a tax deduction, if his or her income is more than $121,000, and the non-working spouse loses the deduction, when household income is more than $199,000. Contributions can still be made to traditional IRA accounts, regardless of a household’s income, and when withdrawals are made, the couple is only liable for taxes on the earnings accrued on the non-deductible contribution.
Backdoor Roth IRA Contribution. The IRS doesn’t allow individuals who earn more than $135,000, or couples who earn more than $199,000, to contribute directly to a Roth IRA. But you can still contribute to a traditional IRA, then convert the money to a Roth IRA. Since you already paid taxes on the traditional IRA contribution, the only tax you owe is on the appreciation the money earns prior to the conversion to the Roth IRA. So, you need to make certain that you do the conversion quickly to limit the amount of time your money can grow and the amount of tax you owe on that growth once the conversion takes place.
Before you do anything with a Backdoor Roth IRA Contribution, be mindful of this: conversions become complex, if you own other IRAs. The IRS does not permit people who have traditional IRAs (with pre- and post-tax money) from converting only the post-tax money. You do have the option to roll all of your pre-tax money into your current company’s 401(k) plan and leave a post-tax contribution of $5,500 in your IRA. Then you can convert that to your Roth IRA. You will want to work with an experienced estate planning attorney to make sure this is handled correctly.
Reference: Investopedia (April 9, 2018) “2 Ways to Reduce Taxes and Save More for Retirement”