Even if your income is too high to contribute directly to a Roth IRA, you may still be able to fund a Roth retirement account. Here are three options to consider.
Contribute to a Roth 401(k) at work.
Roth 401(k)s work a lot like Roth IRAs. With both types of accounts, the income you contribute is taxed before it enters the account, earnings grow tax-free, and withdrawals in retirement are tax-free, provided certain requirements are met. But Roth 401(k) accounts offer a few advantages that Roth IRAs do not.
- Roth 401(k) accounts do not have income limits so you can contribute no matter how high your income.
- Roth 401(k) accounts have much higher annual contribution limits. For 2021, you may be able to contribute as much as $19,500 ($26,000 if age 50 or older) to a Roth 401(k). With a Roth IRA, the most you may be able to contribute is $6,000 ($7,000 if age 50 or older).
- Your employer may match a portion of the money you contribute to your Roth 401(k) account.
If investing in a Roth account is right for you, a Roth 401(k) can be a good account to use.
Try the backdoor.
If income limits prevent you from contributing directly to a Roth IRA, you may want to use a strategy known as a backdoor Roth contribution to gain access to a Roth IRA.
This strategy involves making a nondeductible contribution to a traditional IRA and then converting the assets in the traditional IRA to a Roth IRA. There are no income limits on contributing to a traditional IRA or converting a traditional IRA to a Roth IRA.
If you do not have other assets in traditional IRAs, the only part of the conversion that will be taxable will be any investment growth that occurs between when you make the nondeductible contribution and when you convert it.
If you have other assets in traditional IRAs, the tax calculation gets more complex and the tax bill on the conversion may be considerably larger. So before using this strategy, please seek advice from your financial professional regarding its potential tax impact.
Convert to a Roth account.
Savings that you have in a traditional IRA can generally be converted to a Roth IRA. You will pay income tax on that taxable portion of the conversion in the year of the conversion, but from then on earnings grow tax-free and withdrawals in retirement are tax-free as long as certain requirements are met.
If your traditional IRA contains mainly deductible contributions and earnings, the tax bill on the conversion can be sizable. It’s a good idea to evaluation the tax impact first and to consider what your tax rate may be in retirement.
If you expect your tax rate to be lower in retirement than it is now, you may pay less tax overall if you leave your money in the traditional IRA and pay the tax during retirement as you make withdrawals from the account. But if you expect your tax rate to be higher in retirement, a Roth conversion may be a good move, particularly if you can afford to pay the tax with money from outside the IRA.
Article published in November 2021 edition of Eye on Money. If you would like to be added to our mail list please email [email protected].