NerdWallet's Smart Money Podcast
End-of-Year IRA Fixes Before Tax Time: Roth Contribution and Correction Strategies
16 Dec 2024
Chapter 1: What are lazy money management strategies?
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.
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Chapter 2: How can I automate my investments?
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.
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Chapter 3: What is dollar-cost averaging and why is it useful?
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.
Chapter 4: What are target date funds and how do they work?
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 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.
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Chapter 5: How to set up a backdoor Roth IRA?
For example, if you over-contributed $1,000 in 2024 and you discover this after October 15th, 2025, you're gonna have to eat the $60 penalty for 2024, but you can avoid future penalties by limiting your contributions to $6,000 rather than $7,000 in 2025.
Chapter 6: What should I do if I over-contribute to my Roth IRA?
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.
Chapter 7: How do I fix previous Roth IRA contributions?
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 earn 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.
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