Don't give up quickly if your path to contributing to a Roth IRA is blocked by tax law limits. Despite the obstacles, upper-income taxpayers may be able to take advantage of a backdoor Roth IRA.
IRA contribution basics
Unlike a traditional IRA where contributions may be wholly or partially tax-deductible, contributions to a Roth can never be deducted, but future distributions are generally exempt from tax. In contrast, traditional IRA distributions may be taxable in full.
The contribution limit for any combination of traditional and Roth IRAs for the 2018 tax year is $5,500 (increased to $6,000 for 2019). Plus, you can add on $1,000 if you're 50 or older.
But there are no income limits on taxpayers who contribute to traditional IRAs. With a Roth, the ability to contribute is phased out, based on your modified adjusted gross income (MAGI).
- For the 2018 tax year, the phaseout for single filers occurs between $120,000 and $135,000 of MAGI ($122,000 to $137,000 for 2019).
- For the 2018 tax year, the phaseout for joint filers occurs between $189,000 and $199,000 of MAGI ($193,000 to $203,000 for 2019).
Conversions and backdoor Roth IRAs
Of course, you can convert an existing traditional IRA to a Roth, but you must pay tax on the conversion at ordinary income rates. Currently, the top rate is 37 percent.
However, this clever tax technique may work for you: Fund a traditional IRA with nondeductible contributions. Then, when you convert to a Roth, you only pay tax on the portion representing taxable earnings. The bulk of the conversion is tax-free. This "back-door IRA" approach remains viable after recent tax legislation.
There are additional complications if you already have other IRAs. But you may be able to minimize the tax damage by rolling over those funds into a 401(k) or other plan.
Call before you make your move, or if you have questions about your IRA tax obligations.