Roth IRA accounts have existed since 1997, but interest has increased recently, particularly since a 2010 tax law change that allows all taxpayers to convert traditional IRAs into Roth IRAs regardless of income level.
Many investors choose a Roth IRA as a way to diversify retirement accounts for tax planning in retirement.
Still, there are income limits that apply to Roth IRA contributions.
Source: Internal Revenue Service
Some investors may want to use Roth IRAs but cannot make contributions because their income level is too high.
Here are three ways that higher earners can build savings in a Roth account:
1. Fund a non-deductible IRA and then convert it to a Roth IRA
Investors could fund a non-deductible IRA and then convert it to a Roth IRA. Because the non-deductible IRA is funded with after-tax funds, these funds are not taxed upon conversion. It is important to note, however, that if the investor owns other pretax IRAs (including SEP and SIMPLE), the tax calculation upon converting would be subject to the “pro-rata” rule. This means that all IRA assets are considered in aggregate to calculate the percentage of after-tax IRA assets to pretax IRA assets. See an example in “Non-deductible IRA contributions and Roth conversions.”
Another consideration is for married couples. If one spouse does not own any pretax IRAs, the conversion could be made without tax liability.
2. Direct salary deferrals into a Roth 401(k) plan at work
Roth 401(k) plans were first introduced in tax law in 2001 and made permanent in 2006. The number of companies offering a Roth 401(k) option for salary deferrals has been increasing every year. In this type of Roth account, there are no income limits and investors can contribute more than if they used a traditional IRA. For 2015, the maximum contribution is $18,000 with an extra $6,000 allowed if the investor is age 50 or older.
3. Make after-tax contributions inside your retirement plan
Some retirement plans may allow allow after-tax contributions inside the plan when a participant has maxed out their salary deferral.
The IRS also recently provided clarification on how to distribute funds when a plan participant has a mix of pre-tax and after-tax assets in their retirement plan. According to the IRS guidance, plan participants can direct after-tax retirement assets directly to a Roth IRA tax free, when it is time for distribution.
Read more details in “IRS opens door to direct retirement assets to a Roth.”
When considering a strategy it is important to consult an advisor or tax expert with knowledge of your individual financial situation and overall retirement plan.