First of all, you make how much money?
Congratulations!
If you make so much money you can’t contribute to a Roth IRA, then a certain amount of back slapping and high-fiving are in order.
If you need a refresher on the Roth IRA limits to determine if you can contribute, we’ve got your back:
| If You Have Taxable Compensation and Your Filing Status Is… | And Your Modified AGI Is… | Then… |
|---|---|---|
| married filing jointly or qualifying widow(er) | Less than $173,000 | you can contribute up to the limit. |
at least $173,000 but less than $183,000 | the amount you can contribute is reduced. | |
$183,000 or more | you cannot contribute to a Roth IRA. | |
| married filing separately and you lived with your spouse at any time during the year | zero (-0-) | you can contribute up to the limit. |
more than zero (-0-) but less than $10,000 | the amount you can contribute is reduced. | |
$10,000 or more | you cannot contribute to a Roth IRA. | |
| single, head of household, or married filing separately and you did not live with your spouse at any time during the year | less than $110,000 | you can contribute up to the limit. |
at least $110,000 but less than $125,000 | the amount you can contribute is reduced. | |
$125,000 or more | you cannot contribute to a Roth IRA. |
Information courtesy of the IRS
A couple things to point out in our table above:
– First, don’t think just because you make a lot of money and your spouse doesn’t that you can just file “married and separate.” The IRS thought you might consider that maneuver, and now caps income at $10,000 for those who consider that loop-hole.
Also, be aware of what “Modified” AGI means. Leave it to the government to complicate an already complex issue.
Here’s how you calculate your “Modified” AGI (also courtesy of the IRS)
Modified AGI. Your modified AGI for Roth IRA purposes is your adjusted gross income (AGI) as shown on your return modified as follows.
- Subtracting the following.
- Roth IRA conversions included on Form 1040, line 15b; Form 1040A, line 11b; or Form 1040NR, line 16b. Conversions are discussed under Can You Move Amounts Into a Roth IRA, later.
- Roth IRA rollovers from qualified retirement plans included on Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b.
- Add the following deductions and exclusions:
- Traditional IRA deduction,
- Student loan interest deduction,
- Tuition and fees deduction,
- Domestic production activities deduction,
- Foreign earned income exclusion,
- Foreign housing exclusion or deduction,
- Exclusion of qualified bond interest shown on Form 8815, and
- Exclusion of employer-provided adoption benefits shown on Form 8839.
- First, open a non-deductible IRA at your favorite brokerage house (Fidelity, E-trade, Schwab, etc.).
- Next, fund your non-deductible IRA up to your maximum IRA contribution limit ($5,000 for those under 50; $6,000 for those turning 50 in the tax year of the contribution);
- Wait at least 30 days, or a statement cycle so you can show the money was in an IRA – *DO NOT INVEST YOUR MONEY DURING THIS 30 DAY WAITING PERIOD;
- Then, call your brokerage firm and perform a Roth IRA Conversion of your IRA money. You’ll owe tax on the gain (probably just a couple cents of interest), but other than that…pretty easy!
You’ll likely have to fill out a special tax form next year (IRS Form 8606) discussing the conversion, but there will be no tax, no penalty, and now you have a Roth IRA.
A couple of rules:
- If you have other IRA money (other than the $5,000 you just put in), you cannot just tell the IRS you want to convert the non-taxable kind. You have to convert IRAs pro-rata which mean only a percentage of your money will be tax free. If you have other IRA money (not 401(k) money, IRA money), before embarking on this strategy – discuss this with a knowledgeable tax advisor who knows what they’re taking about.
- Unlike a normal Roth IRA contribution, you do not have immediate access to these dollars. You can access them after 5 years – just like any other conversion monies.
- Don’t tempt fate and try to do this at the end of a tax year. There are too many chances for last minute screw-ups. Complete this process during the middle part of the year so you have plenty of time to fix problems before the year’s over. The IRS doesn’t like multiple 1099 forms and stuff like that…as an aside, neither does your accountant.
So there…badaboom, badabing. Now even the 1%-ers can have a Roth. Just like Congress intended.
Got to love the loopholes! Have I mentioned that the IRS are a bunch of morons? lol.
We’ve found the IRS to actually be quite savvy. Just endure an audit and you’ll know. Also, this is far from a loophole. Those fortunate people who find themselves in the 28%+ marginal tax bracket will more than likely find this to be not as advantageous as initially thought. Especially if tax on LT CG and dividends remain low relative to their ordinary income tax rate.
While I agree this isn’t a loophole, I think converting money to a Roth IRA whenever possible is advantageous to buy as much flexibility as possible. If I can convert money to a Roth IRA and still contribute to my 401k, there’s no downside to buying more flexibility for retirement.
That comment wasn’t exactly meant to be taken literally. I’m sure there are some very smart people that work at the IRS. My sarcasm was meant to be slanted like, ‘the tax system itself is just plain stupid.’
That’s a personal opinion though so we don’t really need to get into a debate about it.
And I would agree with your other statement about the LT CG taxes but who doesn’t think taxes are going to go up over the next 20 years? Personally, I’m taking advantage of any opportunity to ensure that I don’t get taxed down the road.
I actually don’t think taxes will significantly go up for the middle class in the next 20 years. Over the last 35 years, a family making $50k has had essentially the same effective tax rate (avg 14.3%). taxes have pretty much remained the same for the middle class. We did a whole blog post on FIT rates all the way back to 1913. http://wp.me/p2h40p-R
And as someone who has only been able to contribute to a Roth IRA for a few select years in my life, I’ve drawn the conclusion doing what is in this blog post isn’t the best for me. And I’ve even put some math to it and done some quantitative analysis opposed to getting sucked into the boilerplate “paying fewer taxes.” It’s interesting…http://wp.me/p2h40p-1c
and don’t even get me started on future tax risks of retirement funds, especially ROTH accounts.
Now you’ve peaked my interest, what are these future tax risks for ROTH accounts?
Love how you added, “just like Congress intended,” at the end there. Duh, who would have thought they could be so stupid as to overlook something like this? Obviously, many of them take advantage of this exact “loophole.”
It is comforting to know though, that there are still some ways that high achievers can avoid getting screwed by Uncle Sam. Thanks for this reminder post, complete with all the details. I had heard about this, but haven’t really thought about it since trucking isn’t quite in that earnings bracket yet.
Just like we added “…Congress intended,” I like how you added “yet” to the end of your comment, Matt!
Out of curiosity, how is one “getting screwed by Uncle Sam” if they can’t contribute to a Roth account?
Cool stuff. (kinda sad that I think that’s cool stuff, but what can you do…)
Guys like you and I take our cool where we can get it, Dr. Dean!
You know what’s funny? A Roth IRA is how Mrs. YFS and I plan to fund our future child’s education account. We have to do the conversion trick but if junior get a scholarship at least we don’t get burned with the 10% penalty by a 529 plan for not using funds for education.
I bought my son a left-handed mitt when he was three years old. My dad said, “What the hell you doing that for?” I just looked at him and he said, “No, way! Really?” Turned out he was a swimmer and becoming a lefty wouldn’t really help his cause….
Good advice, and I’ll remember it if I ever become so fortunate to bring in this kind of income. Even if you didn’t want to go through the hassle of converting, a traditional IRA is still not bad!
I just head about this exact issue this past week. The advice given was to contribute to a regular IRA… and then transfer it to a roth IRA. Apparently, with such a high income you can’t make contributions, but you can make transfers. Might be worth looking into?
See my post on this earlier (link in the piece), but that’s the great thing about the Roth…because there’s no tax implication on the contribution, you’re free to take it whenever you wish.