Iras

Backdoor Roths and beyond: The four camps who can benefit Roth IRA conversions can unlock serious savings, especially if you find yourself in one of these scenarios. Roth IRAs and their tax-free perks are pretty great—so great that in some scenarios, it can make sense to convert pre-tax dollars from traditional retirement accounts into post-tax dollars in a Roth IRA. This is what’s known as a Roth conversion. You’re effectively taking those pre-tax funds and telling Uncle Sam you’d rather pay taxes on them now in exchange for the benefit of tax-free and penalty-free withdrawals in retirement. And if you need the money earlier, the IRS requires only that you wait five years before withdrawing each conversion to avoid a 10% penalty. So who do Roth conversions appeal to in particular? Four types of people: High earners and the “backdoor” Roth conversion Recent retirees and unwelcome RMDs Early retirees and the Roth conversion “ladder” People experiencing temporary income dips High earners and the “backdoor” Roth conversion Did you know the IRS restricts access to Roth IRAs based on income? Shut the front door! Yes, if your income exceeds these eligibility limits, you can’t contribute directly to a Roth IRA. But as the saying goes, when one door closes, another door opens. A “backdoor,” more specifically. So if you make too much money, fear not – you can contribute indirectly to a Roth IRA via a Roth conversion widely known as a “backdoor” Roth. This entails contributing post-tax dollars first to a traditional IRA, then converting those funds to a Roth IRA. If you’ve never contributed to a traditional IRA before, pulling off a backdoor Roth can be simple, especially if you use Betterment. Open both a traditional and Roth IRA with us, fund the traditional, then convert those funds to your Roth IRA once they’ve settled. Done! If you have any existing traditional IRA funds, however, things get a little more complicated due to something called the pro rata rule. In short, you need to move any pre-tax dollars out of your traditional IRA(s) into an employer-sponsored retirement account like a 401(k) before you can use the account as a backdoor. This gets even more complicated if you have both pre- and post-tax dollars mixed together in your traditional IRA(s). Before going down the road of a backdoor Roth conversion, or any Roth conversion really, we highly recommend seeking the advice of a financial advisor, as well as a tax advisor in certain cases. They can help assess both your current situation and future projections. Recent retirees and unwelcome RMDs The IRS doesn’t let you keep funds in your traditional retirement accounts indefinitely. They’re meant to be spent, after all. So starting at age 73, annual required minimum distributions (RMDs) from these accounts kick in. RMDs aren’t inherently a bad thing, but if your expenses can already be covered from other sources, RMDs will just raise your tax bill unnecessarily. You can get ahead of this and lower your future amount of RMDs by converting traditional account funds to a Roth IRA before you reach RMD age. That’s because Roth IRAs are exempt from RMDs. And as an added benefit, you’ll minimize taxes on Social Security benefits and Medicare premiums later on in retirement. Just make sure you convert those funds before you turn 73, because once RMDs kick in, those amounts can’t be converted. Early retirees and the Roth conversion “ladder” If you want to retire early, even by “just” a few years, you very well might encounter a problem: Most of your retirement savings are tied up in tax-advantaged 401(k)s and IRAs, which slap you with a 10% penalty if you withdraw the funds before the age of 59 ½. A few exceptions to this early withdrawal rule exist, the biggest for early retirees being that contributions to a Roth IRA (i.e., not the gains you may see on those contributions) can be withdrawn early without taxes or penalties, in this specific order: “Regular” contributions made directly to a Roth IRA. As an aside, you can always withdraw these funds tax-free and penalty-free without waiting five years. Once you’ve burned through regular contributions, the IRS allows you to withdraw contributions that were converted from traditional 401(k)s and traditional IRAs! You won’t pay any additional taxes on these withdrawn contributions because taxes have already been paid. But withdrawn conversions (item #2 above) typically are still subject to a 10% penalty if withdrawn before 5 years. Think of this rule as a speed bump in an otherwise swift shortcut. So what does all of this mean for early retirees? Starting five years before they plan on retiring, they can create a “ladder” looking something like the table below (note: dollar amounts are hypothetical). They convert funds each year, pay taxes on them at that time, then withdraw them five years later 10% penalty-free and sans any additional taxes. Time Amount converted Amount withdrawn Source of withdrawal 5 years pre-retirement $40,000 $0 N/A 4 years pre-retirement $40,000 $0 N/A 3 years pre-retirement $40,000 $0 N/A 2 years pre-retirement $40,000 $0 N/A 1 year pre-retirement $40,000 $0 N/A Retired early! 🎉 Year 1 of retirement $40,000 $40,000 5 years pre-retirement Year 2 of retirement $40,000 $40,000 4 years pre-retirement Year 3 of retirement $40,000 $40,000 3 years pre-retirement Year 4 of retirement $40,000 $40,000 2 years pre-retirement Year 5 of retirement $40,000 $40,000 1 year pre-retirement Etc. Etc. Etc. Etc. People experiencing temporary income dips Say you find yourself staring at a significantly smaller income for the year. Maybe you lost your job. Maybe you work on commission and had a down year. Or maybe you had a big tax writeoff. Whatever the reason, that dip in income means you’re currently in a lower tax bracket, and it may be wise to pay taxes on some of your pre-tax investments now at that lower rate compared to the higher rate when your income bounces back. Watch out for potential Roth conversion pitfalls Each of these scenarios requires careful tax planning, so again, we recommend working with a trusted financial advisor and/or tax advisor. They can help you avoid the most common Roth conversion mistakes and take full advantage of this post-tax money maneuver. Our CERTIFIED FINANCIAL PLANNER™ professionals are here to offer on-demand guidance.

What’s an IRA and how does it work? Learn more about this investment account with tax advantages that help you prepare for retirement. An Individual Retirement Account (IRA) is a type of investment account with tax advantages that helps you prepare for retirement. Depending on the type of IRA you invest in, you can make tax-free withdrawals when you retire, earn tax-free interest, or put off paying taxes until retirement. The sooner you start investing in an IRA, the more time you have to accrue interest before you reach retirement age. But an IRA isn’t the only kind of investment account for retirement planning. And there are multiple types of IRAs available. If you’re planning for retirement, it’s important to understand your options and learn how to maximize your tax benefits. If your employer offers a 401(k), it may be a better option than investing in an IRA. While anyone can open an IRA, employers typically match a portion of your contribution to a 401(k) account, helping your investment grow faster. In this article, we’ll walk you through: What makes an IRA different from a 401(k) The types of IRAs How to choose between a Roth IRA and a Traditional IRA Timing your IRA contributions IRA recharacterizations Roth IRA conversions Let’s start by looking at what makes an Individual Retirement Account different from a 401(k). How is an IRA different from a 401(k)? When it comes to retirement planning, the two most common investment accounts people talk about are IRAs and 401(k)s. 401(k)s offer similar tax advantages to IRAs, but not everyone has this option. Anyone can start an IRA, but a 401(k) is what’s known as an employer-sponsored retirement plan. It’s only available through an employer. Other differences between these two types of accounts are that: Employers often match a percentage of your contributions to a 401(k) 401(k) contributions come right out of your paycheck 401(k) contribution limits are significantly higher If your employer matches contributions to a 401(k), they’re basically giving you free money you wouldn’t otherwise receive. It’s typically wise to take advantage of this match before looking to an IRA. With an Individual Retirement Account, you determine exactly when and how to make contributions. You can put money into an IRA at any time over the course of the year, whereas a 401(k) almost always has to come from your paycheck. Note that annual IRA contributions can be made up until that year’s tax filing deadline, whereas the contribution deadline for 401(k)s is at the end of each calendar year. Learning how to time your IRA contributions can significantly increase your earnings over time. Every year, you’re only allowed to put a fixed amount of money into a retirement account, and the exact amount often changes year-to-year. For an IRA, the contribution limit for 2026 is $7,500 if you’re under 50, or $8,600 if you’re 50 or older. For a 401(k), the contribution limit for 2026 is $24,500 if you’re under 50, or $32,500 if you’re 50 or older. These contribution limits are separate, so it’s not uncommon for investors to have both a 401(k) and an IRA. And as a side note for those 50 or older, starting in 2026, 401(k) catch-up contributions must go into a Roth 401(k) specifically if you received more than $145,000 in FICA wages (salaries, commissions, etc.) the prior year. What are the types of IRAs? The challenge for most people looking into IRAs is understanding which kind of IRA is most advantageous for them. For many, this boils down to Roth and/or Traditional. The advantages of each can shift over time as tax laws and your income level changes, so this is a common periodic question for even advanced investors. As a side note, there are other IRA options suited for the self-employed or small business owner, such as the SEP IRA, but we won’t go into those here. As mentioned in the section above, IRA contributions are not made directly from your paycheck. That means that the money you are contributing to an IRA has already been taxed. When you contribute to a Traditional IRA, your contribution may be tax-deductible. Whether you are eligible to take a full, partial, or any deduction at all depends on if you or your spouse is covered by an employer retirement plan (i.e. a 401(k)) and your income level (more on these limitations later). Once funds are in your Traditional IRA, you will not pay any income taxes on investment earnings until you begin to withdraw from the account. This means that you benefit from “tax-deferred” growth. If you were able to deduct your contributions, you will pay income tax on the contributions as well as earnings at the time of withdrawal. If you were not eligible to take a deduction on your contributions, then you generally will only pay taxes on the earnings at the time of withdrawal. This is done on a “pro-rata” basis. Comparatively, contributions to a Roth IRA are not tax deductible. When it comes time to withdraw from your Roth IRA, your withdrawals will generally be tax free—even the interest you’ve accumulated. How to choose between a Roth IRA and a Traditional IRA For most people, choosing an Individual Retirement Account is a matter of deciding between a Roth IRA and a Traditional IRA. Neither option is inherently better: it depends on your income and your tax bracket now and in retirement. Your income determines whether you can contribute to a Roth IRA, and also whether you are eligible to deduct contributions made to a Traditional IRA. However, the IRS doesn’t use your gross income; they look at your modified adjusted gross income, which can be different from taxable income. With Roth IRAs, your ability to contribute is phased out when your modified adjusted gross income (MAGI) reaches a certain level. If you’re eligible for both types of IRAs, the choice often comes down to what tax bracket you’re in now, and what tax bracket you think you’ll be in when you retire. If you think you’ll be in a lower tax bracket when you retire, postponing taxes with a Traditional IRA will likely result in you keeping more of your money. If you expect to be in a higher tax bracket when you retire, using a Roth IRA to pay taxes now may be the better choice. The best type of account for you may change over time, but making a choice now doesn’t lock you into one option forever. So as you start retirement planning, focus on where you are now and where you’d like to be then. It’s healthy to re-evaluate your position periodically, especially when you go through major financial transitions such as getting a new job, losing a job, receiving a promotion, or creating an additional revenue stream. Timing IRA contributions: why earlier is better Regardless of which type of IRA you select, it helps to understand how the timing of your contributions impacts your investment returns. It’s your choice to either make a maximum contribution early in the year, contribute over time, or wait until the deadline. By timing your contribution to be as early as possible, you can maximize your time in the market, which could help you gain more returns over time. Consider the difference between making a maximum contribution on January 1 and making it on December 1 each year. Then suppose, hypothetically, that your annual growth rate is 10%. Here’s what the difference could look like between an IRA with early contributions and an IRA with late contributions: This figure represents the scenarios mentioned above.‘Deposit Early’ indicates depositing $6,000 on January 1 of each calendar year, whereas ‘Deposit Late’ indicates depositing $6,000 on December 1 of the same calendar year, both every year for a ten-year period. Calculations assume a hypothetical growth rate of 10% annually. The hypothetical growth rate is not based on, and should not be interpreted to reflect, any Betterment portfolio, or any other investment or portfolio, and is purely an arbitrary number. Further, the results are solely based on the calculations mentioned in the preceding sentences. These figures do not take into account any dividend reinvestment, taxes, market changes, or any fees charged. The illustration does not reflect the chance for loss or gain, and actual returns can vary from those above. What’s an IRA recharacterization? You might contribute to an IRA before you have started filing your taxes and may not know exactly what your Modified Adjusted Gross Income will be for that year. Therefore, you may not know whether you will be eligible to contribute to a Roth IRA, or if you will be able to deduct your contributions to a Traditional IRA. In some cases, the IRS allows you to reclassify your IRA contributions. A recharacterization changes your contributions (plus the gains or minus the losses attributed to them) from a Traditional IRA to a Roth IRA, or, from a Roth IRA to a Traditional IRA. It’s most common to recharacterize a Roth IRA to a Traditional IRA. Generally, there are no taxes associated with a recharacterization if the amount you recharacterize includes gains or excludes dollars lost. Here are three instances where a recharacterization may be right for you: If you made a Roth contribution during the year but discovered later that your income was high enough to reduce the amount you were allowed to contribute—or prohibit you from contributing at all. If you contributed to a Traditional IRA because you thought your income would be above the allowed limits for a Roth IRA contribution, but your income ended up lower than you’d expected. If you contributed to a Roth IRA, but while preparing your tax return, you realize that you’d benefit more from the immediate tax deduction a Traditional IRA contribution would potentially provide. Additionally, we have listed a few methods that can be used to correct an over-contribution to an IRA in this FAQ resource. You cannot recharacterize an amount that’s more than your allowable maximum annual contribution. You have until each year’s tax filing deadline to recharacterize—unless you file for an extension or you file an amended tax return. What’s a Roth conversion? A Roth conversion is a one-way street. It’s a potentially taxable event where funds are transferred from a Traditional IRA to a Roth IRA. There is no such thing as a Roth to Traditional conversion. It is different from a recharacterization because you are not changing the type of IRA that you contributed to for that particular year. There is no cap on the amount that’s eligible to be converted, so the sky’s the limit for those that choose to convert. We go into Roth conversions in more detail in our Help Center.

Solo 401(k)s vs. SEP IRAs: Sizing up your saving options while self-employed Both retirement accounts offer high contribution limits, but which one is right for you? If you’re self-employed, you likely wear several ill-fitting hats: accountant, admin, HR rep. And that last one is low-key important, because it means no one is setting up a retirement plan for you. So what's a gig worker, small business owner, or solo practitioner to do? There’s the trusty IRA, of course. But its tax benefits phase out at certain income levels, and its $7,500 annual contribution limit fills up fast. You may want—or need—to save more to realize your retirement goal. Luckily, two lesser-known retirement accounts offer self-employed workers 10x more capacity for tax-advantaged investing: the solo 401(k) and the SEP IRA. They’re similar in that sense (high contribution limits), but they also differ in some important ways. We’ve found that for many self-employed workers, choosing between the two often hinges on their hiring or lack thereof: 👉 No employees beyond a spouse, and no plans to hire? Consider a solo if you prioritize Roth access and a slight edge in contribution limits. Consider a SEP if you prioritize less administrative work. 👉 See yourself hiring a few employees in the not-so-distant future? Consider starting with a solo 401(k), then transitioning to a group 401(k) plan if you prioritize Roth access and more flexibility in how you structure employee contributions. Consider a SEP for slightly easier admin, and the ability to pause contributions to your employees’ SEPs during down years. 👉 Planning to expand beyond 5-10 employees at some point? Consider the solo-to-group 401(k) move for more flexibility in how you structure employee contributions. You can max out your own retirement savings, for example, while letting employees decide their own contribution rates. That’s the TL;DR version. For a deeper dive, let’s compare the two accounts across a few categories: High contribution limits Easy admin Roth access Small business growth High contribution limits Both accounts let you save plenty for retirement—upwards of $70,000 a year—but solos give you a couple of ways to stretch that even further: Case #1: You’re playing catch-up If you're age 50 or older and catching up on your retirement savings, a solo 401(k) offers additional “catch-up” contributions of $7,500 each year, or $11,250 for those 60-63. Note that starting in 2026, any catch-up contributions must go into a Roth solo specifically (more on those below) if you received more than $145,000 in FICA wages (salaries, commissions, etc.) the prior year from your solo’s sponsoring company. Case #2: You’re a middle class super saver Say you earn less than $280,000, but you save well above the standard advice of 10-15% for retirement. In this scenario, you may run up against the SEP’s 25% compensation cap before you reach its overall $70,000 limit. But with solos, you can contribute as both an employer (up to 25% of compensation) and an employee (up to $23,500) until you hit the overall limit. ⚖️ Advantage: solo 401(k) Easy admin Both a solo 401(k) and SEP IRA, assuming they’re streamlined digital offerings such as ours, are simple to set up. You can open a Betterment SEP entirely online, while a Betterment solo requires a quick call with our Licensed Concierge team to get the ball rolling. Each account type is relatively low maintenance as well. Neither a SEP nor a solo require annual paperwork, with the one exception being for solo 401(k) balances that exceed $250,000. In that case, the IRS requires solo owners (aka “sponsors”) to file Form 5500-EZ. While we’re not a tax advisor, and always recommend working with one, the form is relatively straightforward to fill out. ⚖️ Advantage: SEP IRA Roth access Solos and SEPs are designed for retirement, so the IRS gives special tax treatment to both account types. But in practice, solos give you not one but two different flavors of tax treatment to choose from: You can contribute with pre-tax dollars via a traditional solo 401(k), lowering your taxes now and freeing up more money to invest. You also have the ability to contribute with after-tax dollars via a Roth solo 401(k), enjoying tax-free withdrawals in retirement. And Roth solo 401(k)s come with two added bonuses: Unlike traditional retirement accounts, they’re not subject to Required Minimum Distributions (RMDs) in retirement. Unlike Roth IRAs, they come with no income limits of any kind. Roth SEP IRAs, meanwhile, have technically been allowed by the IRS since 2023, but few providers have rolled them out yet. ⚖️ Advantage: Solo 401(k) Small business growth At some point in your self-employed journey, you may bring on hired help. In this case, it’s possible to transition both account types to accommodate employees. Some SEP providers let you shift from a solo practitioner to an employer who contributes to employees’ SEP IRAs on their behalf. But there’s a catch: you must contribute the same amount to their SEPs as you do your own, which may prove challenging depending on your business. With solo 401(k)s, on the other hand, you can include a spouse from the get-go, provided they’re an employee or co-owner of the business. And if you see the potential for expanding beyond a handful of employees down the road, it may make sense to simply transition your solo 401(k) to a group 401(k) plan and enjoy more flexibility in how you structure contributions for your team. Our support team handles moves like this often and can help you when the time comes. ⚖️ Advantage: Solo 401(k) So which account is right for you? The good news is both SEP IRAs and solo 401(k)s offer excellent tax advantages that can help you reach retirement quicker. We offer both at Betterment, and make it easy to open either one. Because when you’re self-employed, you’re busy running your business. Optimizing your retirement savings? Leave that to us for one less hat in your wardrobe.