Wednesday, February 22, 2012

Roth IRA Contributions for Higher Income Individuals

In 2010, Congress removed the income limitation to do a conversion to a Roth IRA.  This created a loophole for high income people unable to make Roth IRA contributions due to income limitations.   These people could now open a Roth IRA account via a two step process: make a non-deductible contribution to a traditional IRA and convert the traditional IRA to a Roth IRA.  In certain cases, the Roth conversion may even be tax free.

According to the IRS tables, in 2012 Single taxpayers making over $125,000 and Married Filing Joint taxpayers making over $183,000 are not eligible to make a contribution to a Roth IRA.  Here's how these taxpayers could contribute to a Roth IRA  for the 2012 tax year.
  • Contribute to a Traditional IRA.  Make a contribution to a traditional IRA in 2012.  Everyone with wage income can contribute up to their earned income or $10,000 ($11,000 for 50 and older), which ever is lower.   High wage earners can make a non-deductible (after tax) contribution to a traditional IRA. 

  • Convert to a Roth IRA.  In 2012,  convert the traditional IRA to a Roth IRA.  Taxes will be owed on the contributions that were previously deductible or rolled over from a 401K plan.  The IRS won't allow taxpayers to cherry pick and roll over only the non-deductible (basis) portion.   The taxpayer's entire amounts in all IRA will need to be included.   However, if the 2012 contribution is the only IRA the taxpayer has, most if not all of the conversion will be not taxed since only the earnings above the contribution will be taxed.

  • File form 8606.  For the taxpayer's 2012 tax return, file form 8606 to inform the IRS that a Roth conversion has been done.
  • After completing these steps, a taxpayer will have a Roth IRA even though he was above the income threshhold to contribute directly to a Roth IRA in 2012.

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    This is not financial, tax, or retirement saving advice. Please consult a professional advisor.

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