Make Too Much to Fund a Roth IRA? These Three Strategies Could Help You!

Taxes drive a lot of our personal finance and many everyday decisions. Strategies to minimize taxes, both now and in retirement, drive many investing decisions as well.

One potential way to minimize taxes in retirement is by investing in a Roth IRA. With a Roth IRA, the account is funded with after-tax dollars by making contributions or Roth conversions. Earnings and capital gains on qualifying withdrawals are tax-free in retirement.

Roth IRAs, however, have two restrictions that can prevent you from contributing money into a Roth IRA.

Restriction #1: Income Phase-Out

Higher-income earners are limited or restricted from contributing to a Roth IRA. Below are the income limits for 2021. If your Modified Adjusted Gross income is in the phase-out, you may be able to make a partial contribution. If you reach age 50 by the end of the year, you are eligible to make an additional $1,000 “catch-up” contribution.

Roth IRA (Single) Roth IRA (Married)
Income Phase-Out
$125k < $140k $198k < $208k
 Contribution Limits $6,000
Catch-Up Contribution (50+) $1,000

Restriction #2: Earned Income Requirement

If you don’t have any earned income reported to the IRS, you can’t contribute to a Roth IRA because your contributions can’t exceed your income.

For example, let’s assume Jim is single and over 50 in 2021. Jim makes $3,000 for the year. The most Jim can contribute to a Roth IRA is $3,000 in 2021.

However, 2022 looks better for Jim for making Roth IRA contributions because he met the love of his life, Gail, while playing tennis at the Dellwood Country Club in White Bear Lake, MN. Gail makes $100,000 / year. If Jim and Gail get married, Jim can contribute $7,000 in 2022 ($6,000 + $1,000 catch-up).

Two ways you could get around the above requirements would be to make less money or get married. If those strategies are not appealing to you, the good news is that there are three practical strategies you could use to get money into a Roth IRA.

Strategy 1) Roth IRA Conversions

A Roth conversion involves moving money from a tax-deferred retirement account (e.g., Traditional IRA or 401(k)) into Roth IRA. You will be required to pay income taxes on tax-deferred money, but all earnings and gains are tax-free for qualifying withdrawals.

There are ZERO income restrictions or limits on Roth IRA conversions. Three options for moving tax-deferred money into a Roth account are as follows:

  • Convert funds from a Traditional IRA into a Roth IRA

One great advantage of a Roth IRA conversion is that principal contributions inside a Roth IRA can be accessed tax and penalty-free before age 59 1/2. Conversions can be accessed after five years.

  • Convert funds inside a Traditional 401(k)/403(b) into a Roth 401(k)/Roth 403(b)

Recently, congress changed the law so that plans can offer in-service Roth conversions. Unfortunately, the vast majority of the plans we analyze for clients do not offer this feature.

Unlike a Roth IRA, Roth 403(b) and Roth 401(k) accounts do not offer tax-free withdrawals of conversions before age 59 ½. However, they may offer loans that are typically limited to $50k and involve paying loan interest and administrative fees.

  • Roll over funds from an eligible company retirement plan (401(k), 403(b), etc.) into a Traditional IRA. From there, you can convert them into a Roth IRA.

If you have separated from service at your place of employment, you should be able to roll over your account into a Traditional IRA. Also, some plans allow for in-service withdrawals. Work with your advisor to analyze your options or check with your plan provider to determine if you are eligible for a Rollover.

Strategy 2) Increase Tax Deductions to Lower Your Modified Adjusted Gross Income (MAGI)

If you are near that income phase-out, talk to your planner and tax accountant about strategies that could lower your income. A few popular strategies that we talk to our clients about are:

  • Increasing contributions to tax-deferred retirement plans (401(k), 403(b), SEP IRA, etc.)
  • Increasing charitable giving or batching giving (e.g., give three years to a charity now instead of giving over the next three years)
  • Setting money aside into a tax-deductible health savings account
  • Participating in a dependent care flex spending account

Strategy 3) The Backdoor Roth IRA

For investors who are not eligible to contribute to a Roth IRA because their income is too high, one strategy to consider is a “Backdoor Roth.” A backdoor Roth IRA is a legal way to get around the income limits that typically restrict high earners from contributing to a Roth IRA. Here’s how it works:

Step #1: Contribute after-tax money into a traditional IRA, which doesn’t have any restrictions for high-income earners.

Step #2: Convert money from the traditional IRA into a Roth IRA.

A quick note on taxes: Any tax-deferred money in the IRA that is converted into the Roth IRA triggers income taxes. For example, Betty contributes $6,000 of after-tax money into her Traditional IRA. Betty waits two months before she executes her Roth IRA conversion. Betty’s account was $6,600 at the time of the conversion. Betty now will owe income taxes on the $600 gain.

Step #3: Enjoy the benefits of having tax-free income in the future!

Unlike tax-deferred 401(k) and 403(b) plans, investors can access their Roth IRA principal contributions (money that they put into their account) tax-free BEFORE RETIREMENT without a penalty. They can even access Roth conversions tax-free after five years.

When it comes to getting more money into a Roth IRA, we highly recommend consulting a financial planner or personal tax professional regarding the strategies above. There may be significant tax implications if not done properly.

If you are interested in learning more about whether Roth IRA contributions, Roth 401(k) contributions, or Roth IRA conversions could help significantly lower your tax bill or give you more control over your money, please contact us for a complimentary consultation!

At One Life Financial Group, we can help you create a plan for your money that allows you to enjoy your wealth today while feeling secure about your financial future. We work with small business owners, doctors, and business executives daily to explore opportunities to help protect and grow their wealth.