If you expect to be in a relatively high tax bracket during your retirement years, you should consider putting as much money as you can into Roth IRAs. Unfortunately, your ability to make annual Roth contributions may be reduced or eliminated by a phase-out rule that affects high-income individuals. The good news is that you can circumvent the phase-out rule by making an annual non-deductible contribution to a traditional IRA and then converting the account into a Roth IRA. This two-part series will first examine some basic information about Roth IRAs and the contribution rules that apply to them, then explain the strategy of contributing and converting.

Making Annual Roth IRA Contributions

The idea of annual Roth IRA contributions makes the most sense if you believe you’ll pay the same or higher tax rates once you enter retirement. Higher future taxes can be avoided on Roth account earnings because qualified Roth withdrawals are federal-income-tax-free (and usually state-income-tax-free, too). The downside is you get no tax deductions for Roth contributions.

The maximum amount you can contribute for any tax year to any IRA, including a Roth account, is the lesser of:

  • Your earned income for that year
  • The annual IRA contribution limit for that year

For 2013, the annual IRA contribution limit is $5,500 or $6,500 if you’ll be age 50 or older by the end of the year.

If you’re married, both you and your spouse can make annual contributions to your separate IRAs as long as you have sufficient earned income. For this purpose, you can add your earned income and your spouse’s earned income together, assuming you file jointly. As long as your combined earned income equals or exceeds your combined IRA contributions, you’re both good.

Income Restriction

For 2013, eligibility to make annual Roth contributions is phased out between modified adjusted gross income (MAGI) of $112,000 and $127,000 for unmarried individuals. For married joint filers, the 2013 phase-out range is between joint MAGI of $178,000 and $188,000. To calculate MAGI, start with your “regular” AGI from the last line on page 1 of Form 1040. Then add back any of the following that apply:

  • Deduction for traditional IRA contributions
  • Deduction for higher-education tuition and fees
  • Deduction for student loan interest
  • Tax-free employer adoption assistance payments
  • Tax-free interest from U.S. Savings Bonds redeemed to pay higher-education costs
  • Education for domestic production activities
  • Certain tax-free allowances for foreign earned income and housing

Part two of this series will highlight a strategy for circumventing the income restriction and look at other catches to be aware of when looking for IRA conversion opportunities.

 

 

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