Can I Contribute to an IRA and Convert to a Roth if I Am Over the Income Limit?
Original post by Leslie McClintock of Demand Media
Many people are attracted by the tax-free growth offered in Roth IRA accounts: It simplifies retirement planning and eases potential estate tax burdens. But until recently, there was an income cap of $100,000 on conversions to Roth IRAs. That income cap was lifted in 2010, allowing anyone to roll unlimited traditional IRA balances into Roth accounts, provided they paid income taxes due. But there was also an income limit on making new contributions to Roth IRAs. Fortunately, the law allows a workaround.
Non-Deductible IRA Contributions
As of 2011, the maximum allowable contribution to a traditional IRA is $5,000 per year, or $6,000 for taxpayers over age 50. The income limits still apply, but they don't restrict your ability to contribute up to $5,000 (or $6,000, if applicable) to a traditional IRA; they only restrict your ability to deduct that contribution against income. You can still make nondeductible contributions to a traditional IRA, regardless of your income.
Converting to a Roth IRA
Since Roth IRA contributions are not deductible, there is no real difference between an IRA contribution and making a non-deductible contribution to a traditional IRA and then converting it to a Roth IRA (unless you have an existing deductible traditional IRA, see below). If you file your taxes correctly, you will have an IRS Form 8606 that documents your non-deductible contributions to the IRA. The IRS does not charge income tax on money attributable to contributions upon which you already paid income taxes.
Make sure to make the conversion soon after you make the contribution, so there is no difference in value of the account between the two. If there was an increase in value, you would have to pay tax on that (since it was not part of the non-deductible contribution); also, if you withdraw these amounts from your Roth IRA within 5 years, the percentage that was earnings when you converted would be subject to penalty; you don't want that.
Danger if you have Existing Traditional IRA
The above description (contributing to a non-deductible traditional IRA and then converting is the same as contributing to a Roth IRA) is only correct if you don't have any existing deductible traditional IRAs. When you convert some amount of traditional IRA into Roth IRA, it automatically converts both deductible and non-deductible portions (if you have any) pro-rata. You cannot simply choose to convert only non-deductible funds if you have deductible funds, and vice versa -- you are forced to convert both. Also, it doesn't matter if you "separate" the non-deductible funds in a separate IRA account that was contributed in a different year; all traditional IRAs anywhere are considered when applying the pro-rata rule.
When the deductible portion is converted, you will have to pay a tax on it. If you have existing deductible traditional IRAs, carefully consider the tax you will have to pay on conversion. Some people are able to avoid this problem by rolling their deductible traditional IRA funds into a 401(k); not all 401(k) plans allow this.
You can roll over any balance from a traditional IRA to a Roth, regardless of the amount, and regardless of your income. However, you must complete the rollover within 60 days of initiation, or you will not only have to pay income taxes on the balance, but also a 10 percent penalty if you are under age 59 1/2.
Roth IRA Income Limitations
Who might use a nondeductible IRA contribution as a way to fund a Roth IRA? Married couples who earn more than $169,000 per year, or single individuals making more than $107,000 per year. Up to that income level, you can make the full $5,000 contribution directly to a Roth IRA. Your allowable contribution reduces gradually the more you make, until your allowance disappears at an income of $122,000, as of 2011. If you make over this amount, and you still want to contribute to a Roth IRA, you will need to use a traditional IRA as a conduit and convert your balance.
- Kiplinger.com: Should I Make Non-Deductible IRA Contributions? Kimberly Lankford: February 10, 2010
- Your-Roth-IRA.com: 2011 Roth IRA Conversion Rules
- Internal Revenue Service: Publication 590 - Individual Retirement Arrangements
About the Author
Leslie McClintock has been writing professionally since 2001. She has been published in "Wealth and Retirement Planner," "Senior Market Advisor," "The Annuity Selling Guide," and many other outlets. A licensed life and health insurance agent, McClintock holds a B.A. from the University of Southern California.