Getting Around the Roth IRA Funding Limitations
With tax time right around the corner, investors and their advisors alike are figuring out what, if any, IRA contributions they are eligible to make for 2016. The Roth IRA is an after tax IRA that is a great account to fund and invest in if you are eligible to.
Remember, the Roth IRA is funded with after tax money (money in your checking or savings account). It grows tax free, can be distributed tax free after age 59.5, and inherits tax free if it is never used. Unlike the traditional, pre-tax IRA, you can access your principal tax and penalty free if you need to, as long as the account has been open for 5 years or more.
Unfortunately, not everyone is eligible to contribute to the Roth IRA. For 2016, the contribution limit is phased out for adjusted gross incomes between $117,000-132,000 for single filers and $184,000-194,000 for joint filers.
There is a little-known and even lesser utilized loophole, however, that can circumvent these income limits for higher earners. It works like this:
- An investor can fund a non-deductible IRA. For 2016, the contribution limits are $5,500 if you are under 50 years old, and $6,500 if you are over. Anyone can fund a non-deductible IRA.
- He or she can then convert the non-deductible IRA to a Roth IRA. Recent legislation has taken away the Roth Conversion income limitation, so anyone with an IRA can now convert.
There are some hindrances to this, however. Without going into too much detail…If you have any kind of pre-tax IRA (traditional, SEP, SIMPLE), then this loophole can’t be utilized to its fullest extent, if at all. You’re only able to convert the same proportion that your non-deductible IRA makes up of your total IRA assets. For example, if you have a regular, pre-tax IRA worth $100,000, and you fund a non-deductible IRA for $5,000, you can only convert 5% of that non-deductible IRA to the Roth IRA tax free. Of course, you can still do a full traditional conversion, but you would owe taxes on it.
However, if all of your pre-tax retirement money is tied up in your company 401K, you have no IRAs, and you earn too much to fund a Roth in the traditional manner, then this is definitely something to look into and take advantage of.
Please give us a call if you would like to discuss your personal situation, and we will help determine if this strategy will work for you.