Author Topic: Roth IRA/IRA/other options for higher income earner?  (Read 4321 times)

Valkyrie

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Roth IRA/IRA/other options for higher income earner?
« on: September 23, 2013, 12:55:47 AM »
Hi everyone, I searched and searched in these forums/the site and elsewhere for an answer to my dilemma but I'm hoping you guys can help me out.

I'm a 27 year-old software developer and my AGI is well above $127,000 this year (max 2013 for partial Roth IRA contribution), even after accounting for 401k contributions. Last year my AGI was low enough to contribute to a Roth IRA, but not this year.

I have maxed out my 401k already and already contributed a few thousand to my Roth IRA before I knew about the limits. Here are my questions:

  • Is there any way I can contribute to a Roth IRA or a traditional IRA with my income?
  • What about the money I already put into my Roth? Vanguard lets me put even more in there, but obviously it doesn't know about my income. Will I need to pay it back somehow?
  • I received a large bonus this year of about $40k -- if I can't put it into an IRA, should I just buy more Vanguard funds and accept the capital gains when I eventually withdraw it?

Thank you so much!

seattlecyclone

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Re: Roth IRA/IRA/other options for higher income earner?
« Reply #1 on: September 23, 2013, 02:13:02 AM »
1) Yes, there is a roundabout process where you can contribute to a Roth IRA. It's called a "backdoor IRA conversion". It involves making a non-deductible contribution to a traditional IRA and immediately rolling it over into a Roth. The link goes over it in more detail, including a common pitfall: if you already have made tax-deferred contribution to a traditional IRA, the backdoor strategy doesn't work as well.
2) The money that you already put into your Roth will be considered an "excess contribution". You'll have to pay a 6% penalty tax on the excess amount this year and all future years (at least until your income dips below the maximum) that the money remains in the account. To avoid the penalty, take the money out. Talk to Vanguard for more instructions on how to do this.
3) Yes, once you've exhausted all available tax shelters your only alternative is to invest in a taxable account. Be happy! Having too much money to invest is not a bad thing!

Valkyrie

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Re: Roth IRA/IRA/other options for higher income earner?
« Reply #2 on: September 23, 2013, 02:40:47 AM »
Thank you for the response! I have a few more questions that may sound ignorant. I've only ever considered a Roth IRA so I'm kind of confused on traditional IRAs.

Using the backdoor process, it sounds like I open a new Vanguard account for a traditional IRA, can put a max of $5,500 in this account (despite my income), then convert it to a Roth IRA as soon as possible? Though I've read the article you linked and the contribution limits for a traditional IRA, I'm still confused as to whether or not my income prevents me from contributing.

Regarding the tax for the over contribution to my Roth, when is this tax applied?

Thanks again!

chasesfish

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Re: Roth IRA/IRA/other options for higher income earner?
« Reply #3 on: September 23, 2013, 05:12:19 AM »
Vlkyrie:  I'm in a similar position, I find owning a couple of individual stocks in a regular taxable account (I use Fidelity) is the best option I have.  Here's why:

- You control the capital gains/losses based off what you sell for a year.

- Pick anywhere from 3-10 nice size companies to invest in

- You can pick taking a dividend payer or not (I prefer them) and have them reinvested.  Most dividends still have preferential tax treatment. 

- If you don't like taxes from dividends, one of the best "mutual funds" that doesn't create taxes for you until you sell it is Mr. Buffett's company, Berkshire Hathaway.

You can also sell off just what you need when you need it to manage the tax liabilities.  Mutual funds just send you a statement in December telling you how much that manager earned. 

jrhampt

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Re: Roth IRA/IRA/other options for higher income earner?
« Reply #4 on: September 23, 2013, 05:54:28 AM »
We also just invest in a taxable account once we max out our 401k contributions.  I figure doing the non-deductible IRA is not worth it because then you have the hassle trying to access the money if you retire early.  You can also look into HSA contributions if you have that type of plan available, or iBonds.  I will probably start taking advantage of an HSA this fall.

seattlecyclone

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Re: Roth IRA/IRA/other options for higher income earner?
« Reply #5 on: September 23, 2013, 10:52:45 AM »
Thank you for the response! I have a few more questions that may sound ignorant. I've only ever considered a Roth IRA so I'm kind of confused on traditional IRAs.

Using the backdoor process, it sounds like I open a new Vanguard account for a traditional IRA, can put a max of $5,500 in this account (despite my income), then convert it to a Roth IRA as soon as possible? Though I've read the article you linked and the contribution limits for a traditional IRA, I'm still confused as to whether or not my income prevents me from contributing.

My understanding is that the income limits in place for the traditional IRA are only for whether you can make those contributions pre-tax. This IRS publication talks about this more. You have to file IRS Form 8606 with your taxes so that the IRS knows your contribution was nondeductible (so that you won't be charged tax on that money when you roll it over).

Quote
Regarding the tax for the over contribution to my Roth, when is this tax applied?

You calculate this tax on Form 5329, and report it on line 58 of form 1040 when you file your taxes in the spring.

Valkyrie

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Re: Roth IRA/IRA/other options for higher income earner?
« Reply #6 on: September 23, 2013, 11:54:32 AM »
Thanks to everyone that responded, I appreciate it!

seattlecyclone: I just kicked off the process with Vanguard to do a backdoor conversion for the traditional non-deductible IRA to Roth IRA. Vanguard folks were super helpful and informed when it came to this, as well as the tax information.

chasesfish: have you read any books or do you recommend any resources on managing tax liabilities, or on managing capital losses with your portfolio?

jrhampt: I'll look into the HSA option. I do have an HSA but have not been contributing to it due to ignorance. I will see what I can do.

chasesfish

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Re: Roth IRA/IRA/other options for higher income earner?
« Reply #7 on: September 23, 2013, 06:25:03 PM »
All the information you need to manage the tax liabilities is right there in your account.  Fidelity shows me the position, date I bought it, gain/loss, and whether it's a long or short term gain/loss.

Shares are sold on a first in, first out basis.


chasesfish

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Re: Roth IRA/IRA/other options for higher income earner?
« Reply #8 on: September 24, 2013, 04:34:14 AM »
As for what stocks to buy, ect, I really like listening to a free podcast that comes out daily/weekly called Market Foolery and Motley Fool Money and get familiar with it.  I think the individuals are entertaining and after a few months.  Buy companies that are in it for the long haul, I'm very happy with Costco, Disney, and Whole Foods that I picked up on after listening for months.

Valkyrie

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Thanks for the additional info, chasesfish.

I have another question about the backdoor conversion to a Roth IRA. For the purposes of dollar cost averaging, I like putting a fractional amount into my 401k and Roth IRA each month. Is there a way you can do this with the backdoor conversion? It sounds even if you put a little bit of money each pay period into a non-deductible traditional IRA (which will later be converted), you will end up paying taxes at the end of the year on any gain from the IRA. That's obviously not desirable. Any thoughts?