If you want to contribute to a Roth IRA but think your income is too high, there is another back door option. Here is what you do: Open a Traditional IRA; Make a nondeductible contribution; Convert the contribution to a Roth IRA.
Why go through the trouble of converting money
into a Roth IRA? They are an amazing deal, especially for younger, long-term
planners who want to hedge against higher tax rates in the future. With a Roth
IRA you don’t ever have to take money out, and when you do start taking money
out, it’s all income-tax-free, including the earnings. By contrast, with a
traditional IRA, earnings grow tax-deferred, you have to start taking required
mandatory distributions the year after you turn 70.5, and distributions count
as income. A Roth can help minimize your tax bill come April.
Contributions are still limited to $5,000 (or
$6,000 if you’re 50 and older) each year that grows in the Roth IRA income tax
free. That’s $10,000 (or $12,000 for 50 and older) a year for a married couple.
Income restrictions on conversions were lifted on Jan. 1, 2010, so
anyone—regardless of income—can convert a traditional IRA to a Roth. Once your
modified adjusted gross income is $183,000 for a couple filing jointly or
$125,000 for singles, no Roth IRA contributions are allowed.
Other benefits to having Roth IRA money:
- Medicare premiums are based on income. By regulating how much money comes from retirement accounts the lower your Medicare premium can be.
- Leaving a Roth to a child, he or she will have to take a minimum amount out each year, but the withdrawal is income tax free.
One thing to thoroughly consider before making a
conversion is the pro rata rule. When you calculate the taxes due on a
conversion, you have to take into account all your IRA assets, not just the new
$5,000 nondeductible IRA.