ROTH IRAs are an attractive retirement vehicle for many reasons. However, one limitation is the income limits that come into play when considering contributing to a ROTH IRA. This should not deter you from building up a ROTH IRA over the years as there is a very practical way around these income limitations. First, let’s look at why contributing to this retirement account can be a powerful way to plan for the future.
A ROTH IRA is similar to a common Traditional IRA, but there are some key differences between the two. For 2022, the maximum contributions are the same… $6000 per year and $7000 if you are over the age of 50. There are differences between the two and here are some of the main benefits that a ROTH provides:
– Tax-free growth
– All qualified distributions are tax-free (*Qualified distributions are withdrawals after 59 1/2 as long as the ROTH account is 5 years older or more).
– There is no required minimum distribution age like a Traditional IRA or 401K has. (Currently age 72 1/2). This allows you to have better control of your taxable
income in retirement.
– A ROTH can be passed on to your beneficiaries tax-free.
– Contributions can be withdrawn tax and penalty-free at any time.
As mentioned above, there are income limitations when contributing DIRECTLY to a ROTH IRA. To be eligible to contribute the maximum amount in 2022, your modified adjusted gross income must be less than $129,000 if single or $204,000 if married and filing jointly. Contributions begin phasing out above these levels. If you earn over $144,000 as a single person and $214,000 as a married couple then you are not allowed to contribute anything to a ROTH for the year… Here is where this blog post becomes important!
There is a practical and 100% allowable way to still contribute to a ROTH IRA if you earn above the income thresholds mentioned above. The IRS allows what is called a BACKDOOR ROTH CONTRIBUTION. Here are the steps to fund your ROTH as a high-earner:
1- Make a non-deductible IRA contribution with after-tax dollars into a Traditional IRA. (Chances are if you are phased out of a ROTH IRA because of income limits then you are also not going to be able to write off your full Traditional IRA contribution)
2- Leave the funds in cash so there are no gains that can be liable to taxes
3- Immediately convert the funds to your ROTH IRA
4- Rinse and repeat the following year…and every year after.
This is the way around income limitations the IRS has for ROTH IRA participants. It’s silly that you have to add the extra step of contributing to a Traditional IRA first, but that extra paperwork is a small price to pay for being able to build up a tax-free nest egg regardless of your current income level.