retirement

Getting Around Income Limits for a Roth IRA

Tips for high earners on how to open a Roth without breaking the rules.

I earned too much in 2013 to contribute to a Roth IRA. Can I contribute to a traditional IRA for 2013 and immediately convert it to a Roth? Do I have to pay taxes on the conversion?

Your plan is a perfectly legal backdoor entry to a Roth IRA. For 2013, direct Roth contributions are banned for singles with adjusted gross income over $127,000 and couples filing a joint return reporting AGI over $188,000. But there’s no income limit on contributions to a traditional IRA or for converting one to a Roth. You have until April 15, 2014, to contribute up to $5,500 to a IRA for 2013 (or up to $6,500 if you were 50 or older in 2013).

There’s no legal requirement for how long the money needs to be in the traditional IRA before moving it to a Roth. But Ken Hevert, vice-president of retirement products for Fidelity, notes that it could take a few days before the money is available for the rollover. Check with the traditional IRA sponsor about timing.

Jim Blankenship, a certified financial planner in New Berlin, Ill., generally advises clients to wait at least a few days for recordkeeping purposes (and even as long as a month) before making the conversion. If the contribution and the conversion are on separate monthly statements, he says, it is clear that the original contribution was to a traditional IRA rather than a Roth.

The tax issue is trickier. I’ll assume you make a nondeductible contribution to the traditional IRA (if you or your spouse have a retirement plan at work, the fact that your income is too high for a Roth means it’s also too high to deduct contributions to a traditional IRA). If the new contribution is the first and only money you have put in a traditional IRA, you’ll owe tax only on any earnings between the time of the contribution and the conversion. But if you have other money in traditional IRAs, your tax bill will be based on the ratio of your nondeductible contributions to the total balance in all of your traditional IRAs. So if you make a nondeductible contribution of $5,500 this year and that brings your total in traditional IRAs to $50,000, converting $5,500 to a Roth would trigger a tax on $4,895. Because $5,500 is 11% of $50,000, 11% of the conversion ($605) is considered tax-free; the other 89% ($4,895) is considered pretax money moving from your traditional IRAs to the Roth. If you convert the traditional IRA to a Roth now, you’ll report the conversion on your 2014 return next spring. After the conversion, the money grows tax-free in the Roth. See Why You Need a Roth IRA for more information about the benefits of Roth IRAs.

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