Does Your Income Vary? Get Around Roth IRA Income Limits

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In my post about Roth IRA conversions, commenter JT pointed out a good way to get around the Roth IRA income limits if your income varies from year to year. Simply put contribute to a non-deductible Traditional IRA, and wait until your modified AGI drops below the $100,000 limit to do the conversion into a Roth. Maybe you plan on going back to school or are cutting back your hours to stay home with the kids? Although the limits go away in 2010 anyways, it’s something to consider.

For example, in 2005 I made too much to fully fund my Roth (phase out) but I?d be making less than $100K MAGI (salary – 401k) in 2006, so before April 15th in 2006 I put the excess contribution (4000 – what I was able to contribute directly to my Roth) into a Non-Deductible IRA then did an immediate Roth Conversion (no taxes since there was no gain). Full Roth Contribution even though I was in the phase-out range?

An important note – when you do a Roth Conversion the IRS sees all of your traditional IRAs as a pool, so if you have a traditional IRA from a 401(k) rollover then the above trick doesn?t work since you will owe taxes on a portion of the money?

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  1. Great tip! If I contribute $4000 to a traditional IRA, but don’t get any tax deduction because I earn too much, then convert that $4000 to a Roth IRA down the road when I earn less, do I have to pay taxes on that original $4000 a second time because of an assumption that the money was tax sheltered?

  2. Who the hell is making 100k a year?

  3. This is probably a topic on IRA conversion.

    But, my girl friend has AGI 28K. To qualify for the Saver’s Credit, it has to be less than 25k. I plan to suggest her to put 3100 in Traditional IRA to lower her AGI to less than 25K to qualify for the 10% Saver’s Credit for year 2006.

    Like you mentioned, do an immediate Roth IRA conversions. She will have 3100 more income to report for year 2007, but qualify $200 saver’s credit for the year 2006.

    Any thoughts?

    Single or Married Filing Separately filers: $0-$15,000 get 50 percent credit; $15,001-$16,250, 20 percent credit; $16,251-$25,000, 10 percent credit.

  4. Mike – No, if it was already taxed, you don’t have to pay taxes again.

    Max – Plenty of people apparently 😉 Remember, it’s 100k even for couples. Marriage penalty!

    Luu – I need to do more reading on the Saver’s credit, but maybe someone else knows the answer to that.

  5. Luu – I have the same thought on the saver’s credit, but I still need to do the math to figure out whether this is worth it or not. I’ll be in a higher tax bracket next year, so depending how much I’ll get taxed on the money I put into Traditional IRA, this may not work for me. Other thoughts?

  6. The income phase-out for married couples on a Roth for 2006 starts at $150k and ends at $160k. I believe it goes a few grand higher for 2007 due to “inflation” adjustment.

  7. Those numbers are for direct contributions into a Roth IRA, but if you want to convert a Traditional to a Roth 100k is the limit for both single and married-filing-jointly folk.

  8. Correct Ed.

    The immediate conversion only works for singles with AGI more than 95K and less than 100K in the year after. For married people, if you are in the phase out range (lucky you!), the under 100K thing will have to be either a planned event or unfortunate circumstance (or the 2010 loophole).

    BTW I don’t think they adjust the phase-out limits for inflation, just like they don’t adjust the 100K conversion limit for inflation. Heck they didn’t adjust the ira contribution level for inflation for something like 30 years!

    I still think its a good idea for people to always contribute the maximum to an IRA each year even if they aren’t elligible for a Roth. In a post-tax Non-Roth IRA the gains still grow tax-deferred and I believe the contributions are tax-free when you pull them out. Sheltering as much retirement money as you can from taxes is a good thing.

    Luu, one thing to remember is that when you do the conversion from a pre-tax Traditional IRA to a Roth you owe taxes on the entire amount (but if you were planning to do a Roth anyways this is no big deal). Another thing to investigate is whether the conversion counts towards the following years AGI in regards to the Saver’s credit, if so this may be a one-time only trick…

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