Income too high for a Roth IRA? There is still a way!


You may think like many that because you earn too much money, the door is closed for you to establish and fund a Roth IRA. Despite what you may have heard and believe, there is a legal way that some folks either do not realize, or perhaps have decided not to take advantage of a way to dodge the tax man. First, allow me to explain the deductibility limits for the traditional IRA, and then I will get on my soapbox and preach the benefits of having and contributing to your Roth IRA.

If you are single and make over $73,000 or married and earn more than $121,000, you cannot deduct your traditional IRA contribution of up to $5,500 or up to $6,500 if you are over 50 years old. Regrettably, many of these so-called “rich folks” assume that since they cannot get the deduction, they will not contribute to an IRA. Shame on the shortsightedness! What about the benefits of tax deferral? Well, that is for another day and another column. Now back to the purpose of this dispatch.

Roth IRAs, unlike traditional IRAs, don't allow investors to deduct their contributions from their current taxable income. However, what makes a Roth IRA popular is that it allows savers to withdraw their contributions and any gains tax-free in retirement. Yep, grow your money tax deferred and take it out tax free, as long as you meet certain criteria.

However, the problem that so many peeps have is that Roth IRA contributions are only allowed if one’s modified, adjusted gross income is below a certain level. For single filers in 2018, that income threshold starts at $120,000 and ends at $135,000. In that range, your contribution is limited, eventually reaching zero. For married filing jointly filers, that income threshold starts at $189,000 and ends at $199,000.

So, if you are fortunate or perhaps, unfortunate to some, to make more than the limits mentioned above, you might think the door is locked and you are out of luck. Nope! There is a way, especially if you have no money in a traditional IRA. Moreover, the process is straightforward and simple, as anyone regardless of income can convert a traditional IRA into a Roth IRA.  Do you see where I am going with this? You first establish a traditional IRA and fund it with the maximum amount and then you immediately convert it to a Roth. You do this every year that the technique is available.

Now keep in mind that any earnings in a traditional IRA will be taxed upon conversion. So, if you are really getting this approach and you are beginning to get excited thinking that you will take your existing IRA and convert it to a Roth, you need to calm down, amigo! In the above example, one did not have an IRA. Therefore, since we are converting to a Roth simultaneously from the IRA contribution, there are likely no gains. Thus, there is no tax liability. That, my friends, is the approach to beating the tax man!

Now back to the eager beaver that wants to convert all of his IRA to a Roth. One needs to tiptoe carefully through the arguably treacherous terrain, as one might incur an unexpected tax mess. For example, one must pay tax on any pre-tax IRA contributions as well as any gains in the amount converted to a Roth. When calculating the taxable income from a Roth conversion, you must consider all IRAs in your name (including SIMPLE and SEP IRAs). This is true regardless of whether the IRAs are held at the same financial institution.  

Basically, one must divide the total of after-tax contributions by the total balance across all IRAs (excluding Roth IRAs) to determine the amount of the conversion that is not taxed. There are other things to consider before converting, such as current and future tax rates, potential investment returns, what the money will be used for and when, income and marital status.

Traditional IRA distributions are taxed as ordinary income. Qualified Roth IRA distributions are not subject to state and local taxation in most states. Qualified Roth IRA distributions are also federal tax-free provided a Roth account has been open for at least five years and the owner has reached age 59 ½ or meets other requirements. Both may be subject to 10 percent Federal tax penalty if distributions are taken prior to age 59 ½.

Regrettably, I am afraid that I may have confused more of you than I would like to admit. Nevertheless, please do not ignore the potential to secure what I view as one of the best investment vehicles available today, the Roth IRA!  I urge you to speak with your financial and tax advisor to see if this approach is in your best interest.

Remember, it is never the idea that makes one successful, it is the execution. Stated more simply, if we wait until we feel like doing something worthwhile, we will likely never accomplish it. Let’s choose the pain of discipline over the pain of regret and “Git Er Done!”