NerdWallet's Smart Money Podcast - End-of-Year IRA Fixes Before Tax Time: Roth Contribution and Correction Strategies

Episode Date: December 16, 2024

Discover how to embrace “lazy” money management, maximize Roth IRA contributions and fix over-contribution mistakes. How can you passively grow your money? What should you do if you over-contribute to a Roth IRA? Hosts Sean Pyles and Sara Rathner discuss lazy money-management strategies and Roth IRA over-contribution fixes to help you stay on top of your finances with minimal effort. They begin with a discussion of "lazy" personal finance tips, with actionable advice on automating investments, leveraging savings buckets, and using target-date funds for hands-off financial growth. Then, investing expert Sam Taube joins Sara and co-host Elizabeth Ayoola to discuss managing Roth IRA contributions, especially for those who may have over-contributed. They explore strategies to fix over-contributions, steps for setting up a backdoor Roth IRA, and how to maximize retirement contributions before tax deadlines. Find your next Roth IRA account on our Investing Nerds’ list of the best Roth IRA accounts: https://www.nerdwallet.com/best/investing/roth-ira-accounts  See how your savings and investment account balances can grow with NerdWallet’s free compound interest calculator: https://www.nerdwallet.com/calculator/compound-interest-calculator  Here is the IRS’ guide on the amount of Roth IRA contributions that you can make for 2024: https://www.irs.gov/retirement-plans/plan-participant-employee/amount-of-roth-ira-contributions-that-you-can-make-for-2024  In their conversation, the Nerds discuss: lazy money management, Roth IRA over-contribution, backdoor Roth IRA, automating investments, savings buckets, target-date funds, passive investing, retirement contributions, dollar-cost averaging, financial autopilot, how to fix Roth IRA over-contributions, Roth IRA contribution limit, personal finance podcast, investment mistakes, investing for beginners, retirement planning, retirement savings, tax penalties on Roth IRAs, how to manage finances, savings accounts strategy, budgeting tips, financial organization, avoiding Roth IRA penalties, fixing retirement account errors, best investment strategies, personal finance tips, financial independence, smart money management, lazy ways to save money, easy investment strategies, financial automation, retirement fund mistakes, high-yield savings accounts, joint accounts vs individual accounts, managing childcare expenses, CFP financial advice, IRA custodians, tax filing tips, maximizing retirement contributions, financial stress relief. To send the Nerds your money questions, call or text the Nerd hotline at 901-730-6373 or email [e-mail]. Like what you hear? Please leave us a review and tell a friend.

Hey, Sean, would you describe yourself as lazy? I would say that I'm unlazy to a fault. Like I'm always doing something, cleaning the house or reorganizing a cabinet or going for a run. My partner calls it my scurrying. And at any given moment, you can probably find me flittering about doing one thing or another. So no, I am not lazy. What about you, Sarah? Sometimes, yes, I am. I love rotting on the couch as much as anyone, especially parents of young kids. You know what I'm talking about. After bedtime, couch rot time. It's great. I also make use of every moment I can get things done, either for work or around the house. But believe it or not, sometimes good things can come from being lazy. And I'm not just talking about whatever you're watching on Netflix after your kids go to bed. Welcome to NerdWallet's Smart Money Podcast. I'm Sean Piles. And I'm Sarah Rathner. This episode, I'm joined by our co-host, Elizabeth Ayola, to answer a listener's question about contributing to a Roth IRA when you're over the income limit,

including when a backdoor Roth is a good idea. But first, Sarah and I are going to talk about the virtue of laziness, even if it's something that does not come naturally to me. With the holiday season ramping up, now is actually a great time to be a little lazy with your money. I'm not saying you should neglect your finances, but think about areas where you can put your money on autopilot. And Sarah and I are going to share two areas where we personally like to be a little lazy with our finances. So Sarah, what have you got for us? Well, we're going to talk about low effort ways to hopefully, no guarantees, grow your money by saving and investing. With investing, the hands-on approach

involves a lot of research and attempts at timing the market just so. Or you tell yourself that you do that, but you really just pick investments based on whatever's in the news at the moment. Honestly, the thought of doing that work is daunting for many people, myself included. And it can keep you from getting started in the first place. If you're feeling stuck, going about investing the lazy way could be a way to get past that. One thing to try is setting a monthly investing budget and then depositing that amount into a brokerage account to be invested. And you may know that approach as dollar cost averaging. And as for what to invest in, you don't have to get in on the ground floor of the next hot stock.

Index funds, exchange traded funds, or target date funds are all perfectly fine options. Automate contributions into funds that match your goals and move on with your life. I invest in target date funds in my retirement accounts, for example. I like that they just sort of exist in the background doing their thing while I live my life. I'm also a big fan of dollar cost averaging, which is one of those terms that make you sound very fancy when you say it, but it's just a complicated way of saying lazy investing. Passive or lazy investing like this doesn't stop at how you contribute to your accounts. What you invest in also plays a role. Sarah, you mentioned target date funds, which I'm also a big fan of. For those who may not know, a target date fund is a type of investment that evolves over time.

There are different variations, but often a target date fund will start by investing more aggressively, maybe in stocks that might be riskier and thus have greater growth potential. And then as you get closer to your target date, the types of securities that the fund invests in will change. So for my taxable brokerage account where I make my monthly deposits, that dollar cost averaging that we discussed earlier, I'm invested in a target date fund that about aligns with my retirement date. Seeing as I have nearly 30 years until I plan to retire, my target date fund currently has a more aggressive allocation. Over time, that will change all on its own without me having to do anything. And that's another great way to be lazy and gradually build up my retirement nest egg. Exactly. You know, rethinking your investment

allocations every five or 10 years when it comes to your retirement accounts. Honestly, it's one of those tasks that you're going to forget to do. And then all of a sudden, you'll be five years from retirement invested like you were when you were 25 years old. And that might not be appropriate for you. Putting that stuff on autopilot is a really, really helpful way not just to save yourself time, but also to save you from yourself. And also, we didn't quite mention this part, but I have automated deposits from my checking account into my taxable brokerage account. That's one way you can ensure that you are making these deposits, you are investing gradually without really having to think much about it. Sean, what is your advice for being lazy in a good way with your finances?

My big tip for lazy money management is my savings bucket strategy. Longtime listeners of the podcast have probably heard me talk about this many times before, but I'll give a quick rundown for those who might be newer to the show. In short, I have about 10 checking and savings accounts, which might sound a little extreme or difficult to short, I have about 10 checking and savings accounts, which might sound a little extreme or difficult to manage, but it's really not. Most of my savings accounts are with one institution, and then I have my primary checking account at a local credit union, and I also have an old checking account at a big national bank that I only really keep open because it's still connected to my mom's account, back from when I opened this account in middle school. And she can easily get my portion of the cell phone bill from

that account each month. Hashtag millennial money management. It is deeply millennial to still be on your parents cell phone plan. I'm paying my part of the bill. Okay, that's true. That's true. I'm not on their plan. But yeah. So I have a similar system, cell phone plan, notwithstanding, I have my checking account for direct deposit of my paycheck. And I use that to pay my credit card bills and other kind of monthly bills like utilities and stuff. My high yield savings accounts don't actually limit withdrawals. So I also use them in a way like a checking account at times. And my husband and I maintain accounts for specific purposes, like automated payments for the mortgage or our son's daycare tuition. Those are our two biggest checking account at times. And my husband and I maintain accounts for specific purposes like

automated payments for the mortgage or our son's daycare tuition. Those are our two biggest expenses every month right there. Yes, my husband and I do not have a joint checking account, hashtag millennial money management. And I think that's totally fine. I mean, what you described speaks to how you don't have to force yourself into a prescribed way of managing your money. You just have to find a system that works for you. And in this case, you and your husband and managing the expenses of childcare, which is a lot to do. Anyway, I have all these accounts, but each one has its own goal. Beyond the account where I pay my mom my cell phone money each month, I have a savings account for my wedding, which is finally happening

next year. Another account for my emergency fund, one that I've just called fun money that I put money in for vacations or other discretionary expenses. When I was going through my CFP coursework and making regular payments for my classes, I also had a savings account for that too. All right. So that all makes sense to me because like I said, I manage my money similarly, but what I'm waiting to hear is what exactly is lazy about having all of these accounts? Because there's definitely some work involved, especially when you're setting it up. So bear with me. I will admit that there is a little bit of admin work around setting up these accounts

and the direct deposits into them, but it's not super cumbersome. I just allocate specific percentages of my paycheck into each account. And this is really where the magic happens. Each pay period, my money just goes into these accounts automatically. I don't have to worry about whether I'm adding money to my emergency fund each time I get paid or whether I'll have enough in my checking account to cover my mortgage. I've set up my deposit so I know I'll have enough going into each account for my monthly expenses and long-term savings goals. Then I just sit back and watch it happen. Or I guess, as I mentioned, I'm not exactly

sitting back, but I can check on these accounts while scurrying from one task to another and know that my money is also scurrying to where it's supposed to be as well. So basically, order a pizza, and while you wait, set up some accounts and automated transfers, and honestly, you'll probably be done by the time the pizza arrives, and then you get to reward yourself with a pizza. You know, that's a great idea.

Then you can enjoy your pizza on the couch and bask in your sense of accomplishment and laziness simultaneously. All right, well, we are about to turn to this week's money question segment, where Sarah and our co-host Elizabeth talk about Roth contributions and how you should think about your retirement accounts at the end of the year. But first, it's that time, that very special moment of the podcast, where we turn to you, our listener, and ask, what's up? Where do you need help?

This show is all about your money questions, so send them our way. Leave a voicemail or text us on the Nerd Hotline at 901-730-6373. That's 901-730-NERD. Or email us at podcast at nerdwallet.com. One of our goals for next year is to talk with as many of you on the podcast as possible. So if you have a topic you want to chat with us about, let us know. It could be something big like buying a new house

or something smaller like figuring out your own way to be lazy yet productive with your money. We're all ears. So one more time, leave us a voicemail or text us on the Nerd Hotline at 901-730-6373. That's 901-730-NERD or email us at podcast at nerdwallet.com. This episode's money question is coming up in a moment. Stay with us. We're back and answering your real world questions to help you make smarter decisions about your

money. Now this episode's question comes from a listener's text message and here it is. Hi nerds. According to my wife's and my pay, it looks like by the end of the year, our modified adjusted gross income will put us over the Roth IRA contribution limit. The problem is she and I dollar cost average into the Roth IRA. So we have already contributed about half of this year's limit. Will that be an issue? How can I fix this in tax season? Can I do a backdoor Roth IRA? How do we fix what we have already contributed this year? That's a lot of questions. Yes. And to help us answer this list of questions, on this episode of the podcast, we are joined by investing nerd, Sam Taub.

Sam, welcome back to Smart Money. Thanks. Good to be back. And listener, if you're thinking, why should I keep listening? I don't even have a Roth IRA. Then don't worry. NerdWallet has you covered. Our investing nerds have put together a list of the best Roth IRA, then don't worry. NerdWallet has you covered. Our investing nerds have put

together a list of the best Roth IRA accounts, and we will put a link in the description of today's episode. Or you can search online for NerdWallet best Roth IRA account. Now let's get into this listener's question. Sam, can you start by explaining what the contribution limits are for Roth IRAs this year? Sure, although it's a surprisingly complicated question. The maximum amount you can contribute to IRAs in 2024 is $7,000 or $8,000 if you're over age 50. Now, that's the maximum contribution to any number of IRAs of any type, Roth or traditional.

But there are additional factors in the maximum contribution for Roth accounts. In particular, above a certain income level, the maximum amount you can contribute to a Roth IRA gets reduced by a factor that's based on your modified adjusted gross income. And then there's a second income level above that where you can't contribute to a Roth IRA at all. For single filers, that phase out starts at a modified adjusted gross income of $146,000. And Roth IRA contributions are disallowed entirely at $161,000 or more. So what we don't know is how much our listener and their wife are earning this year. And Sam mentioned the figures for single filers, but for couples who are married filing jointly,

which we can probably assume this listener is doing, the phase out range starts at $228,000 to $240,000. So if any of our listeners fall between that range, they can contribute a reduced amount. But if they earn two hundred and forty thousand dollars or more, they can't contribute to a Roth IRA at all. And there is a calculation that people can do to determine just how much they can contribute if they fall within the phase out range. But I'm guessing they don't want to do that math or they want to make sure it's done correctly. I know that's true for me. So in that case, how should they determine what, if anything, they can contribute? Would it be best to just talk to an accountant? There's definitely a case for just going to an accountant. You could do the calculation yourself, but it's pretty complicated and there's a few different

steps. Even kind of trying to walk through it on a podcast might be hard to follow. The IRS has a handy page that walks you through how to do it. And as we discussed, you can also get professional help for this kind of thing. And we will include a link to that in the episode's show notes. So that's a hint for you to go and check those out. I personally would advocate for using the accountant. I mean, last year I overpaid. I know we're talking about Roths here, but I overpaid on my health savings account and I overpaid on my taxes because I was doing my own math.

This year, I definitely used a CFP. Anyways, it's important that people who might earn too much to contribute the full amount to a Roth IRA, understand what their limits are. If they contribute too much, they could face IRS penalties. That's right. You'll owe a 6% tax on the amount of excess contributions left in a Roth IRA every year. I don't know about you,

but I'm not trying to give Uncle Sam any more of my cash. What about our listeners' recourse if they did contribute more than they're allowed to? What are their options? There are a few different ways to fix that. The sooner you start working on it, the better in general.

If you realize that you over-contributed before you file taxes, most IRA custodians like Vanguard and Fidelity have a return of excess contributions form that you can file with them to just get the excess money back. This is probably the simplest way to fix an over-contribution. The only downside is that you may need to sell some shares in the Roth IRA to come up with the amount of cash you need to withdraw. Another option is to re-characterize your contributions from Roth to traditional IRA when you file taxes. That might be slightly more work if you don't have a traditional IRA because you'll need to open one to do this. But that might also reduce your taxable income for the year because of the new traditional IRA contribution you'd be doing. You'll also need to fill out a form with your IRA custodian to transfer the contribution amount from your Roth IRA to your traditional IRA.

Wow, that's a lot of legwork, but at least we know that they have options. Tell us, Sam, what happens if you don't realize that you contributed too much until after you filed your taxes? There are still ways to fix it, but it's even more legwork if you wait until after you file. If you realize you over-contributed after you file, you can still re-characterize contributions like we were just talking about if you file an amended tax return before October 15th of the following year. So for tax year 2024, that would be October 15th, 2025. There's kind of a paperwork penalty if you wait until after you file to fix it. If you discover an over-contribution after October 15th, you're going to have to pay that 6% penalty on the over-contribution amount for the year.

But you can still fix the issue going forward and avoid further penalties by reducing the amount you contribute the following year by the $60 penalty for 2024. But you can avoid future penalties by limiting your contributions to $6,000 rather than $7,000 in 2025. So that's a lot. And I will actually say I did have one year where I over contributed to a Roth. And I got to be honest with you, I probably entered a fugue state while I just listened to what my accountant told me to do. And then I did it. And then I came out of that fugue state, having corrected the problem. It is really hard and get help if you are feeling confused and overwhelmed, because you definitely want to do this right. Absolutely. So one other thing our listener asked about was a backdoor Roth IRA. Can you give us a super quick

explanation of that? And is that an option for people who contributed too much to their Roth IRA? The backdoor Roth IRA strategy involves opening a new traditional IRA, making non-deductible contributions to it, and then rolling over that traditional IRA into a Roth IRA. It's not necessarily a fix for over-contributing, but it is a way to get around the income limits for Roth contributions. And it means you'll only owe tax on the profits your investments earned in the traditional IRA before you converted it. If you convert a traditional IRA that contains tax-deductible contributions into a Roth, you'll also owe tax on the contributions. So that's why the non-deductible contributions part is important.

Thanks for explaining that. And I'm not going to lie, the first time that I heard about backdoor Roths, I honestly thought they were too good to be true. But anyway, how do people go about doing a backdoor Roth? A backdoor Roth can require a lot of legwork. To characterize contributions as non-deductible, you have to file Form 8606 non-deductible IRAs with the IRS for the year you make the contributions. Then you have to have your IRA custodian convert the traditional IRA to a Roth IRA, and then you have to pay taxes on any investment profits your contributions earned before the conversion. This is another case where you could do all this by yourself, but it's a lot of different steps and a lot of room for error.

It's a good idea to consult a financial advisor or tax professional if you're considering doing a backdoor Roth. And the taxes you have to pay on any investment profits, that's all in one go, right? So that could be potentially a pretty high tax bill all at once. Yeah, definitely. Yeah, something to budget for if you're considering going this route, of course. Shifting gears a little bit, we are heading into the end of the year. And a lot of people are thinking about how they can maximize their retirement contributions before the end of the calendar year. So what options do people have? When it comes to 401k accounts, a lot of custodians allow you to change the percentage

of your paycheck that you're contributing anytime through their app or their website. If you have a workplace retirement plan that matches your contributions, the common advice is to contribute the maximum matched amount if you're able, because it's free money and it's not counted toward your contribution limit. Robinhood, Webull, and SoFi, for example. It's worth reading the fine print on these because some of them are offering the match indefinitely, but others are doing it for a limited time. There are some IRA custodians such as Webull that'll even match a percentage of your account balance when you roll an existing IRA over to them. And just to note here, Robinhood, Webull, and SoFi are nerd wallet partners, but it doesn't affect how we talk about them. All right.

So Sam, finally, do people have to do these now or do they have until the next tax filing season next year? They have until the tax filing deadline next year. That's right. That said, sooner is usually better when it comes to retirement account contributions, because the longer you wait, the more investment returns you're potentially missing out on. Well, Sam, thank you so much for helping us out today. Of course, this is important stuff. I would just add before we leave, and I'm going to put it out there that putting some money

into your IRA is better than nothing, Of course, if you can afford to. If you need some inspiration, because I know holiday spending is coming around, use the compound interest calculator on our website to see how much your contribution could grow in the next few years. And on that note, that's all we have for this episode. Remember, listener, that we're here to answer your money questions. So turn to the nerds and call or text us your questions at 901-730-6373. That's 901-730-NERD. You can also email us at podcast at nerdwallet.com. And lastly, visit nerdwallet.com slash podcast for more info on this episode. And remember, you can follow the show on your favorite podcast app, including Spotify,

Apple Podcasts, and iHeartRadio to automatically download new episodes. And here's our brief disclaimer. We are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances. And with that said, until next time, turn to the nerds.