How To Contribute To A Roth IRA When You Make Too Much Money

Contribute to a Roth IRAFirst off, you can never make too much money. But when it comes to the option of investing for your retirement through a Roth IRA, you can make too much money. As of this writing, you cannot contribute to a Roth IRA if you are single and make more than $122,000 per year or are married filing jointly and make more than $179,000 per year. Note that there are phase-out amounts that are lower than this, meaning that you cannot contribute the full amount but can still contribute. I am not going to confuse you with too many numbers, so just focus on what I have above.

For 2012, you can contribute $5,000 if you are under 50 years old. If you are 50 or older, you are allowed to contribute $6,000. [For 2013 you can contribute $5,500 if you are under 50 years old and $6,500 for those older than 50.]

With that out of the way, let’s see how you can contribute to a Roth IRA if you make too much money. (If you are new to saving for retirement, be sure you know the difference between a Traditional and a Roth IRA.)

Step 1: Open up and fund a Traditional IRA for $5,000 (assuming you are under 50).
Step 2: Convert that Traditional IRA into a Roth. Depending on your custodian, this can be as simple as buying and selling between accounts or involve filling out paperwork.
Step 3: Profit.

It really is this easy. Of course, there are some things you need to know prior to doing this.

  • Any gains made in the Traditional IRA are taxable. This means that if you open and fund a Traditional IRA with $5,000 and it grows to $6,000 before you make the conversion, you are on the hook for that $1,000. To avoid this, open the Traditional IRA one day and when the money is in the account, convert it over. You should also just leave the money in cash to avoid any potential gains.
  • If you have any other non-Roth IRA accounts, the taxable portion of a conversion is pro-rated over all of your IRA accounts. For example, let us say you have three Traditional IRA accounts. In total, you contributed $15,000 into them and they are currently worth $100,000 combined. Any conversion that you make will only be 15% tax-free (15% is the $15,000 in contributions).  You will owe tax on 85% of anything you convert. So, assuming this, if you now open a new Traditional IRA with $5,000 and convert it to a Roth IRA, instead of the entire $5,000 being tax-free, only 15%, or $750 of it is. You have to account for your other IRA accounts. This is why you should not do Roth conversions if you have multiple non-Roth IRA accounts with any gains.

You may be thinking that this all seems a bit shady. I thought so too. But it isn’t. It is perfectly legal with legislation that went into effect in 2010. If it is an unintended consequence, then the IRS will most likely be closing it soon. But in the meantime, take full advantage of it.

If you want to know how to save even more for retirement, read my posts on using your HSA account as a retirement account and the ultimate guide to retiring early.

4 thoughts on “How To Contribute To A Roth IRA When You Make Too Much Money”

  1. Is it actually called a Traditional IRA though? I think it's termed "non-deductible" IRA because there are income limits on the traditional as well.

    I'm not positive but I think that's the case.

    1. In general it's a Traditional IRA. But if you make too much or are covered by a retirement plan at work (401k, etc) the amount you contribute to the Traditional IRA is not deductible. Otherwise it is deductible.

  2. I've heard of this and that it's legit, too. I'd always want my CPA to tell me it's OK for me before I did it, but I know a few people who have done this…

  3. Yes indeed, the smart way to contribute to a Roth is via the traditional (deductible or non-deductible) IRA. Let you take advantage of a couple of different tax loopholes. And I love your step 3 up there. That's really the goal isn't it? 🙂

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