High income earners have been the subject of much of the “fiscal cliff” discussions. It seems that whatever happens to fix this issue it will involve higher taxes on that group of individuals. If you fall into that group it’s easy to feel picked on, but there is still a way to get some tax advantaged accounts…even if we have to use the perfectly legal back door to get there.
Since 1997 the Roth IRA has been an important planning tool for those saving for retirement and worried about higher tax rates. They work pretty simply; you put money in, it grows (hopefully), you take it out tax free after certain requirements are met.
In the past, high earners had been limited in their ability to take advantage of these tax advantaged retirement accounts due to income restrictions. If you are single you cannot make a direct contribution to a Roth account if you make more than $125,000. If you are married the income limit is $183,000. This leaves out a lot of people who are in the best position to utilize these accounts.
However, if you’re willing to put in a little work, there may be a way you can get around those limits and make annual contributions into a Roth IRA.
In 2010 Congress did away with the income limits on “conversions”. So while you still can’t put money directly into a Roth, you can get money through the backdoor and have it land in the same place as if you had made a direct contribution.
So how does this work? Here are the steps
- Make a non-deductable Traditional IRA contribution
- Convert the funds in the Traditional IRA to a ROTH IRA.
While this two-step plan makes it appear easy, you should consult with your tax or financial advisor prior to making this move.
If you already have a large traditional IRA you need to consult with a tax advisor who is familiar with the rules! The pro-rata guidelines could leave you owing an unexpected tax bill.
A direct Roth contribution can be made anytime up until April 15 next year. However, a 2012 IRA conversion to the Roth IRA must be completed by year-end! If you plan to do this, you should get started now.
If you have more questions please visit me at www.carrollinvestmentmanagement.com or call my office at 870-779-1081.
The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax-free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 591/2 may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
Traditional IRA account owners should consider the tax ramification, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.