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Strategies for Maximizing Roth IRA Benefits Despite Income Limits

Strategies for Maximizing Roth IRA Benefits Despite Income Limits

October 18, 2023

The Roth IRA has gained popularity as a favored retirement savings account due to its unique tax advantages. Unlike traditional IRAs, Roth's are funded with after-tax dollars, allowing for tax-free withdrawals of contributions and earnings during retirement, provided the account holder is 59½ or older and has maintained the account for at least five years. Additionally, Roth's are exempt from required minimum distributions (RMDs) starting at age 73, a requirement for tax-deferred retirement accounts.

However, there's a limitation—individuals with incomes exceeding $138,000 in 2023 ($218,000 for married couples filing jointly) are ineligible to contribute the full amount to a Roth IRA. Even for those who qualify, the contribution limit is set at $6,500 per year ($7,500 for individuals aged 50 or older), with reductions for incomes falling between $138,000 and $153,000 (or $218,000 and $228,000 for married couples).

Despite these income limits, there are strategies recommended for higher-income individuals to benefit from Roth accounts.

  1. Roth 401(k): If offered by your employer, this option allows you to contribute up to $22,500 ($30,000 for those aged 50 or older) in after-tax funds in 2023. Unlike Roth IRAs, Roth 401(k)s require mandatory minimum distributions.
  2. Roth Conversion: Individuals with savings in a traditional IRA can convert part or all of the balance to a Roth IRA, incurring ordinary income tax on the converted amount. This conversion can be spread over multiple years to manage the associated tax liability.
  3. Backdoor Roth: If your income is too high for deductible contributions to a traditional IRA, you can make after-tax contributions up to the annual limit and then convert them to a Roth. The pro rata rule, which considers the pre-tax value of the account, applies to all Roth conversions.
  4. Mega-Backdoor Roth IRA: Check with your employer's retirement plan administrator to confirm if your plan allows after-tax contributions above the annual limit and withdrawals while still employed. If so:
  • Max out regular 401(k) contributions.
  • Contribute after-tax dollars up to the overall limit of $66,000 in 2023 ($73,500 for individuals aged 50 or older).
  • Irrevocably transfer the after-tax funds into a Roth IRA promptly to avoid taxation on any earnings.

While these strategies, particularly the mega-backdoor Roth, may seem intricate, it's advised to seek assistance from a tax or financial professional for those interested in pursuing them. Converting from a traditional IRA to a Roth IRA is a taxable event.