High Income Roth IRA Contributions – The Back Door to Obtaining a Tax Benefit for Those Phased Out of ROTH IRA Contributions Due to Income

by Donald Benson CPA, CFP

Many Americans have taken advantage of the tax benefits of contributing to IRAs. They are a great way to save for retirement while taking advantage of tax benefits simultaneously. If you’re a little rusty on the basic IRA rules here they are: 

1) If you contribute to a traditional IRA you may get a tax deduction now and pay tax on the distributions from the account after it has grown over time. 2) A Roth IRA is the exact opposite. You make contributions without any tax break now and withdraw the earnings tax free after it has grown over time.

These benefits are available to most Americans. If you are not covered by an employer retirement plan you can make deductible Traditional IRA contributions regardless of income. However, if you are covered by an employer retirement plan and your adjusted gross income (AGI) is high enough ($71,000 for single individuals and $118,000 for married filing joint in 2015) you are not allowed to make deductible Traditional IRA contributions. Additionally, if your adjusted gross income (AGI) is higher than ($131,000 for single individuals and $193,000 for married filing joint in 2015), you are not allowed to make Roth IRA contributions.

How then can high-incomers fund a Roth IRA account? One technique is called the “back door Roth IRA”. This is a two-step transaction which allows you to make non-deductible contributions to a Traditional IRA, then roll them over to a Roth IRA. Once the funds are within the Roth IRA account they will grow tax-free and can be withdrawn tax free upon retirement. This “back door” to making Roth IRA contributions is perfectly legal and highly effective, allowing those working hard for the American dream to obtain the same tax benefits when saving for retirement as everyone else.

Remember that you must report any income earned between the date of the contribution to the traditional IRA and the date of the rollover to the Roth IRA. However, considering that you can conduct this transaction on a recurring basis the benefits are well worth the extra time necessary to effect the transactions.