Roth IRA contributions are not tax-deductible, so there is no tax benefit for the year of contribution. The tax benefit comes when you take a distribution. If you follow the IRS rules, distributions from Roth IRAs are generally tax-free. Typically, you have to be 59 ½ or older and the account has to have been established for at least five years. Although, there are special rules in the case of death, disability, and conversions.
Not everyone can contribute to a Roth IRA. First, you must have earned income, basically income from a job or self-employment. Secondly, there are income limits for contributing to Roth IRAs. In 2021, if your filing status is married filing joint or qualified widow(er) and your modified adjusted gross income falls between $198,000 and $208,000, you can still contribute to a Roth IRA, but the contribution is limited. If your income is above $208,000, you cannot contribute to a Roth IRA. For single or head of household filers, the phase-out range is $125,000 to $140,000. If you are above $140,000, then you cannot contribute to a Roth IRA. These income ranges can change each year. It is best to consult with a tax professional or an investment advisor to understand if you are eligible to contribute to a Roth IRA and how much.
Backdoor Roth IRA
If your income is too high and you do not qualify to make a Roth IRA contribution, there may still be a way to contribute to one. The strategy uses current tax law, and the term is coined, “backdoor” Roth IRA contribution. First, you make a non-deductible Traditional IRA contribution. This can be done even at high-income levels. Next, you immediately convert that traditional IRA to a Roth IRA; there is no income limitation for these types of Roth IRA conversions.
A Few Words of Caution
Even though the backdoor Roth IRA process seems simple, there are several things to be aware of when completing one. The first thing is the timing of the traditional IRA contribution and the conversion to the Roth IRA is important. If done appropriately there may be no tax due on this transaction. Also, delays in the process could cause gains in the traditional IRA to be taxable upon conversion. In addition, if you already have other traditional IRAs, this strategy may not work for you as it can cause unwelcome tax surprises down the road. Finally, this transaction will generate a 1099-R and will need to be reported on your tax return. Due to the complexity of this strategy, we recommend consulting a tax professional and investment advisor before starting this process.
If you would like to learn more about this strategy to see if it is right for you, please contact one of our team members.
Rebecca Agamaite, MBA
Client Experience Manager, Investment Advisor Representative
Rebecca joined the Advisors Management Group in 2011 as an Investment Advisor Representative. Rebecca brings a great deal of experience to the team having worked for several years at Marshall & IIsley Bank and MetLife.
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