Income Too High to Take Advantage of a Roth IRA? Maybe Not! - Rodgers & Associates
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Income Too High to Take Advantage of a Roth IRA? Maybe Not!

The expiration of the current tax code and the beginning of the new Medicare tax in 2013 may have taxpayers searching for strategies to lessen their tax bite. Withdrawals from Roth IRAs will be exempt from the new tax. One goal to consider should be to get as much money into a Roth as possible. The problem for upper income taxpayers is how to contribute to a Roth IRA with the income limits currently in place. Contri­bu­tions to a Roth are limited by your adjusted gross income (AGI). This year, individuals must earn less than $125,000 and married couples must earn under $183,000 combined.

There is a way around these limits. The strategy takes advantage of the nonde­ductible IRA, which does not have an income limitation. A tradi­tional IRA can hold both deductible and nonde­ductible funds. The hassle will be maintaining records of non-deductible contri­bu­tions and documenting this on your tax return each year a contri­bution is made.

The strategy calls for making nonde­ductible IRA contri­bu­tions when your income is too high to contribute directly to a Roth. You can contribute up to $5,000 ($10,000 per married couple) annually, but the contri­bution is not tax deductible. The annual amounts are increased to $6,000 ($12,000 per married couple) for taxpayers 50 and older. Once the contri­bution is made, you convert the nonde­ductible IRA to a Roth IRA. Since 2010, there are no income limita­tions for Roth conver­sions. This allows upper income taxpayers to indirectly contribute to a Roth account that would otherwise be off-limits.

This strategy of indirectly contributing funds into a Roth IRA will not be effective for taxpayers who already have substantial amounts invested in a tradi­tional IRA because of the “pro rata rule.” This rule requires a taxpayer to include all IRA assets when deter­mining the taxes due on a Roth conversion. While investing indirectly in a Roth IRA isn’t appro­priate for everyone, it can provide a viable option to those with higher incomes who are otherwise unable to contribute to a Roth.