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Roth Hacks for High Earners

wealth Mar 18, 2023

Roth IRAs are one of the best tax-favored accounts to use for retirement investing. Many have heard that high earners are out of luck when it comes to Roth IRAs! This is a money myth, and one I can't wait to bust.

Within a Roth IRA, you invest "after tax" dollars (meaning your contributions are not tax deductible). The contribution limits for this account are much lower than your employer accounts. After age 59 and 1/2, all of the funds in the account can be accessed TAX FREE. Yes, you read that right. Tax free. In addition, Roth IRAs have several other benefits:

  • You can withdraw your contributions (not the growth) at any time.
  • You can make a withdrawal without the 10% penalty before 59 and 1/2 if you use the funds for qualified educational expenses (you will still pay income tax on the earnings portion).
  • You can make a withdrawal of up to $10,000 without any taxes or the 10% penalty before age 59 and 1/2 if you use the funds for a first time home purchase as long as you made the contribution >5 years ago (if it has been less than 5 years, you'll pay income taxes on the distribution).
  • No required minimum distributions in retirement (as opposed to a 401k).

However, there are income limits to contributing directly to a Roth IRA. These limits are indexed for inflation and change yearly, but each year the IRS creates a phase out table that eventually excludes high earners from making any contributions to a Roth IRA. Note, this is your modified adjusted gross income from your tax return - NOT your gross income in general. 

That being said, there is a perfectly legal way to contribute to Roth IRAs if you are above the income limit. It's called a "Backdoor Roth IRA" contribution.

Steps to a "Back Door Roth IRA" Contribution:

1. Open a Roth IRA account, but DO NOT directly contribute to it. Ours is at Vanguard, but Fidelity is another excellent option. A new account can be opened online in just a few minutes.

2. Open a traditional IRA account, ideally at the same brokerage firm for simplicity.

3. Make a contribution to the traditional IRA account.

4. As soon as the money becomes "available" within the account, which may take a day or two, click the button to "Convert to Roth". 

5. Report the non-deductible contribution to your traditional IRA on IRS form 8606 when you file your taxes.

6. Go in and invest the funds. Do not skip this step! Not sure how to do this part, click here to learn how to invest. 

7. Make sure you have beneficiaries designated on the account.


Tax Rules:

- You cannot deduct the Traditional IRA contribution on your taxes if you roll it over to a Roth IRA. If you already deducted the traditional IRA contribution and then decided later to convert it, you'll need to pay that tax deduction back. 

- You owe taxes on whatever money the investment earns in the time period before you converted it to Roth (which should be minimal if you do it right away).

- These contributions must sit for 5 years before you can access them if you are under 59 1/2. This is DIFFERENT than direct Roth IRA contributions.

- There is a relatively complex rule called the pro-rata rule to determine the taxes related to the conversion. The easiest way to avoid this rule entirely is to have a zero balance in all traditional IRAs, SEP IRAs, and SIMPLE IRAs at the end of the year. If you are doing additional retirement investing in these types of accounts, a backdoor Roth IRA may not be a good solution for you. 

So who is the backdoor Roth best for? High income earners who are doing their other pre-tax retirement investing in 401(k)s or 403(b)s through their employer. 



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