Author Topic: Too much income for a Roth IRA, now what?  (Read 9827 times)

poko

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Too much income for a Roth IRA, now what?
« on: March 09, 2014, 11:01:41 AM »
Hi all,

I never really though about what would happen when I earned too much money to contribute to a Roth IRA, but after an unexpected large raise this year (with back pay to the start of the year!), I find myself in this position for 2014. I've already canceled my auto contributions to my Roth (I'd put in about $600 for 2014 already).

So, where do I go from here? Can I just open a new Traditional IRA account as well, or can I only have one "type" of IRA at a time? I'm going to be right around the $130k income mark this year (holy crap what) so I don't think I'm even eligible for the phase out contributions. I'm maxing out my 401k, but that doesn't count toward the gross income for Roth eligibility, does it?

Should I just call Vanguard (they have my Roth) and see what's what? I'm not as familiar with Traditional IRAs, is there anything else I might be missing?

arebelspy

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Re: Too much income for a Roth IRA, now what?
« Reply #1 on: March 09, 2014, 11:16:37 AM »
Yes, call Vanguard.  You can undo those contributions in the same tax year.

Yes, you can have a traditional and Roth at the same time, but only contribute a max of 5500 between the two (i.e. you could do 3000 to one, 2500 to the other, or all to one or the other).. in your case, since you're going to be ineligible for the Roth, you can only contribute to the traditional.
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stash4cash

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Re: Too much income for a Roth IRA, now what?
« Reply #2 on: March 09, 2014, 12:31:26 PM »
As I understand it, theres no taxbreak for him when he contributes to the IRA in this case right but he still gets the benefit of tax-free growth in the IRA until withdrawl?

arebelspy

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Re: Too much income for a Roth IRA, now what?
« Reply #3 on: March 09, 2014, 12:38:53 PM »
As I understand it, theres no taxbreak for him when he contributes to the IRA in this case right but he still gets the benefit of tax-free growth in the IRA until withdrawl?

Huh?  How could you have tax free growth if there was no tax break?  No, a traditional IRA will reduce your tax liability (but you will have to pay taxes later - opposite a Roth, which doesn't reduce your tax liability, but is tax-free later).
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stash4cash

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Re: Too much income for a Roth IRA, now what?
« Reply #4 on: March 09, 2014, 01:07:43 PM »
Sorry, I specifically meant the deduction limit as a "tax break".

poko

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Re: Too much income for a Roth IRA, now what?
« Reply #5 on: March 09, 2014, 02:58:24 PM »
Arebelspy, thanks for the info! I'll vanguard to set up a new Trad. IRA account and hopefully move my existing 2014 contributions over there.

(and, stash4cash, I'm a lady ;)

Zaga

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Re: Too much income for a Roth IRA, now what?
« Reply #6 on: March 09, 2014, 04:41:46 PM »
As I understand it, theres no taxbreak for him when he contributes to the IRA in this case right but he still gets the benefit of tax-free growth in the IRA until withdrawl?

Huh?  How could you have tax free growth if there was no tax break?  No, a traditional IRA will reduce your tax liability (but you will have to pay taxes later - opposite a Roth, which doesn't reduce your tax liability, but is tax-free later).
You're actually wrong, there is a non-deductible Traditional IRA.  It's sort of like a Roth in that you don't get a tax deduction now, but sort of like a deductible IRA that earnings are not taxed until withdrawal.  Poko will almost certainly not be able to use a deductible IRA, the income limits for those are lower than the limits for contributing to a Roth.

What I would look into in Poko's case is called a Backdoor Roth.  She would contribute to a Traditional non-deductible IRA, then roll it to a Roth right away.  Talk to Vanguard, they can walk you through this, it's not a hard process.  You will pay tax on any growth when you roll over, so many people advise contributing, then rolling over the very next day so there isn't any growth to worry about come tax time.

stash4cash

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Re: Too much income for a Roth IRA, now what?
« Reply #7 on: March 09, 2014, 07:53:35 PM »
Arebelspy, thanks for the info! I'll vanguard to set up a new Trad. IRA account and hopefully move my existing 2014 contributions over there.

(and, stash4cash, I'm a lady ;)

It was the 'stache that confused me. :D


skyrefuge

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Re: Too much income for a Roth IRA, now what?
« Reply #8 on: March 10, 2014, 09:19:42 AM »
There is no income limit for a Roth IRA.

Zaga mentioned that above, but I just wanted to repeat it and make it visible since it took 6 replies before someone mentioned it.

Ok, technically there is still a limit, but the "Backdoor Roth" is a standard process that sounds like it would be totally applicable in your case (especially since it sounds like you don't have any existing Traditional IRAs, which is the main impediment).

http://www.bogleheads.org/wiki/Backdoor_Roth_IRA

Additionally, not that is particularly important now, but you might actually be able to contribute without the Backdoor maneuver. Any money contributed to your 401(k) is not included in your Modified Adjusted Gross Income, which is what is used to determine your Roth eligibility. If you gross $130k, and contribute $17.5k to your 401(k), and have no other income, that would put your MAGI at $112.5k, which is below the 2014 limit of $114k-to-$129k.

Mister Fancypants

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Re: Too much income for a Roth IRA, now what?
« Reply #9 on: March 10, 2014, 09:48:46 AM »
There is no income limit for a Roth IRA.

Zaga mentioned that above, but I just wanted to repeat it and make it visible since it took 6 replies before someone mentioned it.

Ok, technically there is still a limit, but the "Backdoor Roth" is a standard process that sounds like it would be totally applicable in your case (especially since it sounds like you don't have any existing Traditional IRAs, which is the main impediment).

http://www.bogleheads.org/wiki/Backdoor_Roth_IRA

Additionally, not that is particularly important now, but you might actually be able to contribute without the Backdoor maneuver. Any money contributed to your 401(k) is not included in your Modified Adjusted Gross Income, which is what is used to determine your Roth eligibility. If you gross $130k, and contribute $17.5k to your 401(k), and have no other income, that would put your MAGI at $112.5k, which is below the 2014 limit of $114k-to-$129k.

I agree with skyrefuge if you make $130 and contribute the full $17.5k to your 401(k) you are below the Roth contribution limits, I would just keep making your Roth contribution until your salary puts you over the limit.

You can then use the backside methodology described to continue to fun your Roth as you down have an existing Traditional IRA.

If/when you switch jobs I might consider keeping your money in a 401(k) to continue giving you access to the Roth backdoor, if you rollover the 401(k) to a traditional IRA the backdoor loses a lot of its appeal.

Good luck,
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FIPurpose

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Re: Too much income for a Roth IRA, now what?
« Reply #10 on: March 10, 2014, 12:00:39 PM »
There is no income limit for a Roth IRA.

Zaga mentioned that above, but I just wanted to repeat it and make it visible since it took 6 replies before someone mentioned it.

Ok, technically there is still a limit, but the "Backdoor Roth" is a standard process that sounds like it would be totally applicable in your case (especially since it sounds like you don't have any existing Traditional IRAs, which is the main impediment).

http://www.bogleheads.org/wiki/Backdoor_Roth_IRA

Additionally, not that is particularly important now, but you might actually be able to contribute without the Backdoor maneuver. Any money contributed to your 401(k) is not included in your Modified Adjusted Gross Income, which is what is used to determine your Roth eligibility. If you gross $130k, and contribute $17.5k to your 401(k), and have no other income, that would put your MAGI at $112.5k, which is below the 2014 limit of $114k-to-$129k.

this doesn't make sense. You say that 401k contributions do not go toward MAGI, then talk about how his 401k contributions would affect his MAGI. Unless you have investment losses or tuition expenses, nothing is deductible from your MAGI.

The backdoor Roth is about the only way you'll get anything extra in a tax -advantaged account.

Cromacster

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Re: Too much income for a Roth IRA, now what?
« Reply #11 on: March 10, 2014, 12:11:27 PM »
There is no income limit for a Roth IRA.

Zaga mentioned that above, but I just wanted to repeat it and make it visible since it took 6 replies before someone mentioned it.

Ok, technically there is still a limit, but the "Backdoor Roth" is a standard process that sounds like it would be totally applicable in your case (especially since it sounds like you don't have any existing Traditional IRAs, which is the main impediment).

http://www.bogleheads.org/wiki/Backdoor_Roth_IRA

Additionally, not that is particularly important now, but you might actually be able to contribute without the Backdoor maneuver. Any money contributed to your 401(k) is not included in your Modified Adjusted Gross Income, which is what is used to determine your Roth eligibility. If you gross $130k, and contribute $17.5k to your 401(k), and have no other income, that would put your MAGI at $112.5k, which is below the 2014 limit of $114k-to-$129k.

this doesn't make sense. You say that 401k contributions do not go toward MAGI, then talk about how his 401k contributions would affect his MAGI. Unless you have investment losses or tuition expenses, nothing is deductible from your MAGI.

The backdoor Roth is about the only way you'll get anything extra in a tax -advantaged account.

Depending on how you look at it.....401(k) is not included in your MAGI.

Or in other words, when calculating your MAGI the 401(k) contributions are still deducted.


bacchi

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Re: Too much income for a Roth IRA, now what?
« Reply #12 on: March 10, 2014, 12:21:47 PM »
Additionally, not that is particularly important now, but you might actually be able to contribute without the Backdoor maneuver. Any money contributed to your 401(k) is not included in your Modified Adjusted Gross Income, which is what is used to determine your Roth eligibility. If you gross $130k, and contribute $17.5k to your 401(k), and have no other income, that would put your MAGI at $112.5k, which is below the 2014 limit of $114k-to-$129k.

this doesn't make sense. You say that 401k contributions do not go toward MAGI, then talk about how his 401k contributions would affect his MAGI. Unless you have investment losses or tuition expenses, nothing is deductible from your MAGI.

It makes sense. The MAGI excludes 401k contributions.

Worksheet 2-1 is helpful here (it takes the AGI and adds back deductions excluding 401k contributions):

http://www.irs.gov/publications/p590/ch02.html#en_US_2013_publink1000230988

130 - 17.5 = 112.5 puts the OP on the cusp of phase out territory.

MissPeach

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Re: Too much income for a Roth IRA, now what?
« Reply #13 on: March 10, 2014, 12:46:35 PM »
I'm in a similar income bracket and put in the full $17.5K into my 401K. I make too much to contribute to a roth. My adjusted income puts me just enough to do a limited traditional IRA contribution but not the entire $5,500. I have an IRA I don't want to roll into my 401K at this time so I'm limited with the backdoor Roth which is my understanding the only option that makes sense. I haven't found any options using IRAs/401Ks if there is no tax advantage other than some asset protection so I don't see any reason to go there.

One thing I found but am still researching is that most 401K allow you to contribute after tax money. The limit is something around $50K. You used to have to roll the after tax money to an IRA and then convert which racked up a lot in taxes. There was supposed to have been a change a few years ago that allows you to roll the after tax portion to an IRA but I haven't found the IRA publication on this; only found articles online and in this forum. I have checked with my 401K plan and it looks like I can roll over after tax contributions several times per year which means if I can backdoor it the gain shouldn't be too bad. But I am still trying to identify all the rules with this.



poko

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Re: Too much income for a Roth IRA, now what?
« Reply #14 on: March 10, 2014, 03:40:41 PM »
Haha, now I'm even more confused! The backdoor IRA looks like what I should be doing, but if my 401k contributions decrease my MAGI (which I will be maxing out) it looks like I don't need to worry about this for 2014.

Though, I did just start participating in my company's ESPP plan, so I probably will have some additional income from the sale of those shares... so maybe I'll just stick with the back door method once I save up the $5k.

Is this something that I could do every year going fwd. i.e. Jan 1st fully fund a traditional IRA, then roll it over to my Roth the next day?

FIPurpose

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Re: Too much income for a Roth IRA, now what?
« Reply #15 on: March 10, 2014, 04:34:38 PM »
Additionally, not that is particularly important now, but you might actually be able to contribute without the Backdoor maneuver. Any money contributed to your 401(k) is not included in your Modified Adjusted Gross Income, which is what is used to determine your Roth eligibility. If you gross $130k, and contribute $17.5k to your 401(k), and have no other income, that would put your MAGI at $112.5k, which is below the 2014 limit of $114k-to-$129k.

this doesn't make sense. You say that 401k contributions do not go toward MAGI, then talk about how his 401k contributions would affect his MAGI. Unless you have investment losses or tuition expenses, nothing is deductible from your MAGI.

It makes sense. The MAGI excludes 401k contributions.

Worksheet 2-1 is helpful here (it takes the AGI and adds back deductions excluding 401k contributions):

http://www.irs.gov/publications/p590/ch02.html#en_US_2013_publink1000230988

130 - 17.5 = 112.5 puts the OP on the cusp of phase out territory.

After reading more on MAGI it's rediculous how much you gain by putting money towards retirement. I know this is off topic but in just considering the Retirement Savings Credit starts with your MAGI, I was amazed by what you can gain by saving for retirement.

For people who are married:

The cutoff for a 10% multiplier is 59,000

So if you and your spouse were maxing out tax contributions:
tIRA contributions $11,000 (5,500 each)
401k contributions $35000 ($17500 each)

Max Saver credit eligible amount is $4000 : Tax Credit is $400

(That means a married couple making $105,000 or less could take this credit if they are able to max out tax deferred accounts)

A couple making $84,500 or less could take an $800 credit

A couple making $81,500 or less could take a $2000 credit.

That's assuming that they could both max out a 401k, but that's rediculous! That's $2000 free bucks that someone in the middle class could receive.


It would be interesting to see how that compares to simply stopping at the 15% tax bracket.
« Last Edit: March 10, 2014, 04:41:40 PM by flyingcircle »

DK

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Re: Too much income for a Roth IRA, now what?
« Reply #16 on: March 17, 2014, 04:45:10 PM »
Additionally, not that is particularly important now, but you might actually be able to contribute without the Backdoor maneuver. Any money contributed to your 401(k) is not included in your Modified Adjusted Gross Income, which is what is used to determine your Roth eligibility. If you gross $130k, and contribute $17.5k to your 401(k), and have no other income, that would put your MAGI at $112.5k, which is below the 2014 limit of $114k-to-$129k.

this doesn't make sense. You say that 401k contributions do not go toward MAGI, then talk about how his 401k contributions would affect his MAGI. Unless you have investment losses or tuition expenses, nothing is deductible from your MAGI.

It makes sense. The MAGI excludes 401k contributions.

Worksheet 2-1 is helpful here (it takes the AGI and adds back deductions excluding 401k contributions):

http://www.irs.gov/publications/p590/ch02.html#en_US_2013_publink1000230988

130 - 17.5 = 112.5 puts the OP on the cusp of phase out territory.

After reading more on MAGI it's rediculous how much you gain by putting money towards retirement. I know this is off topic but in just considering the Retirement Savings Credit starts with your MAGI, I was amazed by what you can gain by saving for retirement.

For people who are married:

The cutoff for a 10% multiplier is 59,000

So if you and your spouse were maxing out tax contributions:
tIRA contributions $11,000 (5,500 each)
401k contributions $35000 ($17500 each)

Max Saver credit eligible amount is $4000 : Tax Credit is $400

(That means a married couple making $105,000 or less could take this credit if they are able to max out tax deferred accounts)

A couple making $84,500 or less could take an $800 credit

A couple making $81,500 or less could take a $2000 credit.

That's assuming that they could both max out a 401k, but that's rediculous! That's $2000 free bucks that someone in the middle class could receive.


It would be interesting to see how that compares to simply stopping at the 15% tax bracket.

I think the cutoff for a couple would be 94,000 if they contributed a max to their 401k's. 59 + 17.5 + 17.5. I'm pretty sure tIRA deductions do not deduct from MAGI.

arebelspy

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Re: Too much income for a Roth IRA, now what?
« Reply #17 on: March 17, 2014, 05:07:19 PM »
Yes, call Vanguard.  You can undo those contributions in the same tax year.

Yes, you can have a traditional and Roth at the same time, but only contribute a max of 5500 between the two (i.e. you could do 3000 to one, 2500 to the other, or all to one or the other).. in your case, since you're going to be ineligible for the Roth, you can only contribute to the traditional.

Wait, YOU CAN? You mean I can switch my Roth contributions for 2013 to a Traditional IRA? OMG, you just made my day.

Yes, but a better way is to recharacterize it.  Then you won't pay taxes on any earnings.

http://finance.zacks.com/can-cancel-roth-ira-contribution-year-3094.html

If there are no earnings, undoing it and contributing to a traditional is the way to go.
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arebelspy

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Re: Too much income for a Roth IRA, now what?
« Reply #18 on: March 17, 2014, 05:31:45 PM »
That's fine.

From Item 3 under recharacterizations in the instructions for form 8606:
Quote
You made a contribution to a Roth IRA and later recharacterized part or all of it to a traditional IRA. Report the nondeductible traditional IRA portion, if any, on Form 8606, Part I. If you did not recharacterize the entire contribution, do not report the remaining Roth IRA portion of the contribution on Form 8606. Attach a statement to your return explaining the recharacterization. If the recharacterization occurred in 2013, include the amount transferred from the Roth IRA on Form 1040, line 15a; Form 1040A, line 11a; or Form 1040NR, line 16a. If the recharacterization occurred in 2014, report the amount transferred only in the attached statement, and not on your 2013 or 2014 tax return.

Example. You are single, covered by a retirement plan, and you contributed $4,000 to a new Roth IRA on June 16, 2013. On December 29, 2013, you determine that your 2013 modified AGI will allow a full traditional IRA deduction. You decide to recharacterize the Roth IRA contribution as a traditional IRA contribution and have $4,200, the balance in the Roth IRA account ($4,000 contribution plus $200 related earnings), transferred from your Roth IRA to a traditional IRA in a trustee-to-trustee transfer. You deduct the $4,000 traditional IRA contribution on Form 1040. You are not required to file Form 8606, but you must attach a statement to your return explaining the recharacterization. The statement indicates that you contributed $4,000 to a new Roth IRA on June 16, 2013; recharacterized that contribution on December 29, 2013, by transferring $4,200, the balance in the Roth IRA, to a traditional IRA in a trustee-to-trustee transfer; and that $4,000 of the traditional IRA contribution is deducted on Form 1040. You include the $4,200 distribution on your 2013 Form 1040, line 15a.

http://www.irs.gov/instructions/i8606/ch01.html
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SoCal

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Re: Too much income for a Roth IRA, now what?
« Reply #19 on: March 17, 2014, 05:51:24 PM »
backdoor Roth works as described if and only if you have no material pre-tax traditional IRA (regular, rollover, SIMPLE) balance

if you have such balances and they are qualified balances, then moving the balance into a 401K will open up the backdoor option. An I401K works for the retired/unemployed.
« Last Edit: March 17, 2014, 05:54:57 PM by SoCal »

arebelspy

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Re: Too much income for a Roth IRA, now what?
« Reply #20 on: March 17, 2014, 07:27:13 PM »
THANK YOU.

No problem, glad to help. :)
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