retirement

How to Fund a Roth IRA If You Earn Too Much

You can make nondeductible contributions to a traditional IRA and convert it to a Roth.

I earn too much money to contribute to a Roth IRA, but I do contribute to an after-tax traditional IRA. Can I convert the traditional IRA to a Roth IRA? Do I have to pay taxes on the conversion?

As you pointed out, you must meet certain income limits to contribute to a Roth IRA. You can contribute to a Roth in 2013 only if your income is less than $127,000 if single or $188,000 if married filing jointly (the amount starts to phase out if you earn more than $112,000 if single or $178,000 if married filing jointly). But there’s no income limit for making nondeductible (after-tax) contributions to a traditional IRA, and there’s no income limit for converting a traditional IRA to a Roth, either.

Your tax liability on the conversion depends on what else is in your traditional IRAs. You do not need to pay taxes on nondeductible contributions when you make the conversion because that money has already been taxed. But you do need to pay taxes on any earnings and money from tax-deductible contributions. And if you’ve made both tax-deductible and nondeductible contributions to several traditional IRAs, you can’t just pick the nondeductible contributions in a single IRA to convert. Instead, your tax bill will be based on the ratio of nondeductible contributions to the total balance in all of your traditional IRAs. If your total balance in traditional IRAs is $100,000, for example, of which $20,000 represents nondeductible contributions, then 20% of any conversion would be tax-free. The rest of the money converted would be taxed at your income tax rate. (Money that is already in a Roth IRA is not included in that calculation.)

You can contribute to a nondeductible IRA every year (up to $5,500 for 2013, or $6,500 if you’re age 50 or older) and immediately convert the money to a Roth. If that’s the only money you have in a traditional IRA, then the conversion will be tax-free. But if you have other money in a traditional IRA, the tax bill will still be based on the ratio of nondeductible contributions to the total balance in all of your traditional IRAs.

For more information about the benefits of Roth IRAs, see Why You Should Open a Roth IRA. For details about the tax calculation for conversions, see IRS Publication 590, Individual Retirement Arrangements.

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