Lower Your Income to Qualify for a Roth

I have been contributing to a Roth IRA for six years, and I like the tax-free advantage of Roth withdrawals. However, our joint income exceeds the allowable limits now. We will make a combined income of $184,000 in 2010. Is there any way to keep my Roth, or am I done?

You can contribute the full $5,000 (or $6,000 if you’re 50 or older) to a Roth IRA for 2010 only if your modified adjusted gross income on a joint return is less than $167,000. You can make partial contributions if you earn from $167,000 to $177,000, but you can’t contribute to a Roth at all if you and your spouse earn more than that. (The contribution limit is phased out for single filers who earn between $105,000 and $120,000.) Even if you can’t make new contributions to the account, however, you can keep the money that’s already there and benefit from tax-free withdrawals in retirement.

Because you’re so close to the income cutoff, you may be able to take a few steps before the end of the year to lower your adjustable gross income so you can qualify for a Roth in 2010. Here are five ways to lower your adjustable gross income:

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1. Boost your 401(k) or 403(b) contributions. Contributing to a retirement plan through work -- such as a 401(k), 403(b) or 457 -- can lower your taxable income. If you and your spouse aren’t on track to invest the maximum $16,500 each for 2010 (or $22,000 each if you’re 50 or older by the end of the year), you can increase your contributions and lower your adjusted gross income -- which could get you closer to the limits to contribute to the Roth.

2. Sell taxable investments for a loss. Capital losses first offset capital gains. After that, you can apply your losses to offset up to $3,000 of ordinary income (any additional losses can be carried over for future tax years). So if you sell losing stocks carefully, you could lower your taxable income by $3,000 in 2010.

3. Contribute to a health savings account. If you have a high-deductible health-insurance policy in 2010 -- with a deductible of at least $1,200 for self-only coverage, or $2,400 for family coverage -- then you can contribute to a health savings account. You can contribute up to $3,050 to an HSA in 2010 if you have self-only coverage, or up to $6,150 if you have family coverage. And you can contribute an extra $1,000 if you’re 55 or older. If your employer offers an HSA, you may be able to make pre-tax contributions to the account; otherwise, your contributions are tax-deductible. Either way, they’ll lower your taxable income and can get you closer to the Roth cutoff. See What to Know About Health Savings Accounts for more information.

4. Lower any income from self-employment. Whether you have a thriving small business or just do some freelance work on the side, you can benefit from a lot of tax breaks for the self-employed. You still have time to buy business equipment and pay other deductible expenses before the end of the year, which can lower your 2010 business income. And you can also make tax-deductible contributions to a small-business retirement plan, such as a simplified employee pension (SEP) or solo 401(k), which can also bring down your taxable income. If you qualify for the self-employed health insurance deduction, you may also be able to deduct your health-insurance premiums. See Tax Toolkit for the Self-Employed for more information about eligible deductions on Schedule C and other tax breaks for self-employed people. You may also want to postpone some year-end billing until 2011 to minimize your income for this year, so you’ll fall just below the Roth cutoffs (but you may want to be careful about deferring too much income into 2011, depending on what may happen to tax rates; see What Will Congress Do to Your Taxes?).

5. Make the most of other deductions. Several other deductions you can make on the first page of your Form 1040 can lower your adjusted gross income, too -- such as moving expenses or alimony you’ve paid. See 71 Ways to Cut Your 2010 Tax Bill. Keep in mind, however, that not all tax-saving moves will lower your modified adjusted gross income, which is the number used to determine whether you qualify for a Roth. See Worksheet 2-1 on page 58 of IRS Publication 590 for help calculating your modified adjusted gross income for Roth IRA purposes.

And if you still can’t make it below the income cutoff, there’s a back door to get into a Roth. Even though your income must be below the limits to make new Roth contributions, the income limit for converting a traditional IRA to a Roth disappeared in 2010. That means you can make a nondeductible contribution to a traditional IRA and then convert the money to a Roth.

If you’ve made both tax-deductible and nondeductible contributions to your traditional IRAs through the years, however, you can’t just cherry-pick the nondeductible contributions to convert and avoid paying taxes. Instead, the taxable amount on the conversion is based on the ratio of nondeductible contributions to the total balance in all of your traditional IRAs. For example, if you have $10,000 in nondeductible contributions and the total balance is $12,000, then 83% of any conversion would be tax-free. For more information, see our special report 2010 Roth Conversions for Everyone.