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What To Do When You You’re Over Roth IRA Income Limits

If you’re single and make more than $127,000 per year or married and jointly make more than $188,000 per year, congrats: You are no longer eligible to contribute to a Roth IRA. How can you still optimize your retirement savings if you’re over Roth IRA income limits?


If you earn too much, you can't contribute to a Roth IRA. Here are some alternative retirement saving strategies. If you’re single and make more than $127,000 per year or married and jointly make more than $188,000 per year, you are over Roth IRA income limits and are no longer eligible to contribute to a Roth IRA.

If this strikes a chord with you — congratulations on being in the top 96 percent of earners in the United States! Unfortunately, you now have a new problem in regards to retirement planning and tax sheltering.

Not to worry. There are plenty of tax-friendly options still available to you.

What originally made a Roth retirement plan so attractive begins to lose its appeal as your earned income rises. With the Roth, you don’t get to claim a tax deduction on invested money; Instead, you pay ordinary taxes up front in exchange for being able to withdraw that money tax-free when you’re over 59 ½ years old. As your income rises, however, so too does your tax bracket. That means you have fewer dollars to invest in that Roth, thus requiring higher returns to make up for that loss.

Max out your 401k

If you work for a company that offers a 401k, that should be the first place you look to maximize your retirement savings. Currently, you can contribute up to $17,500 – up from $17,000 in 2012. With traditional 401ks, everything you deposit is pre-tax. You could lower your current tax liability by a considerable amount with a 401k, but withdrawals will be taxable in retirement.

Many employers are beginning to offer Roth 401ks which follow 401k rules instead of IRA rules, meaning you can still contribute no matter how much you earn. Like a Roth IRA, you cannot deduct contributions to a Roth 401k this year, but withdrawals in retirement will be tax-free.

Don’t forget about traditional IRAs

The traditional IRA has no income limit placed on it, so even if a Roth isn’t an option, a regular IRA will still be available. You’re limited to $5,500 per year, but if you’ve already maxed out your 401k, this is a good way of extending the amount of pre-tax money you can invest while again lowering your tax liabilities.

The IRA will probably have more investment options for you to choose from as well, allowing a further level of diversification that you can’t get with a company-sponsored 401k.

Do a Roth conversion

Regardless of income, you can convert a traditional IRA to a Roth IRA, although no additional amount may be invested once the conversion is completed.

When you convert a traditional IRA into a Roth IRA, you must pay taxes on the converted amount as if it were income in the year you converted. So if you convert $10,000, that amount will be added to your annual income for figuring out your tax return. You will not have to pay taxes again, however, when you withdraw the funds after 59 1/2 years old.

Over-fund life insurance

An unorthodox way to save for retirement is to use equity-indexed universal life insurance. To be clear, this blog recommends most young people steer well clear or any kind of life insurance other than term. But for advanced investors who want to optimize their retirement income with tax-free withdrawals and have exhausted other options, this method may help.

The idea behind this strategy involves over-funding the cash value portion of the insurance policy. Thanks to a loophole in the tax code, cash value can be withdrawn tax-free after the age of 59 ½, making it very similar to a Roth IRA. The main drawback is the expense of maintaining the life insurance policy and long-time horizon needed before this strategy becomes profitable. If you can commit to at least 20 years, over-funding an equity-indexed universal life policy is an alternative path to creating tax-free retirement withdrawals.

Equity-indexed universal life  can be complicated for the individual investor and should be set up with the help of a financial professional you trust. The policy must be set up in a specific way so that you don’t violate any IRS rules that change the insurance type from a tax-efficient one into a taxable one called a Modified Endowment Contract (MEC).

For more information, check out this article on Equity-Indexed Life Insurance.

Just invest

The last option is just to forget about the tax implication of your higher income and simply put more into your savings and brokerage accounts. There are no limitations to how much you can put away every month and the potential returns made in the stock market can very well make up for any negative tax consequences. Capital gains on investments held for more than one year are still less than what you would ordinarily pay on your tax returns, so go ahead and invest with impunity!

To learn more about optimizing your retirement strategy, familiarize yourself with the IRS Tax code regarding retirement for 2013.

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About Daniel Cross

Daniel Cross has been in the industry as an investment writer and financial advisor since 2005. He holds the Chartered Financial Consultant designation (ChFC) as well as Series 7 and Series 66 licenses, and has embarked on the arduous journey of obtaining the coveted CFA designation. Daniel lives in Florida with his wife, daughter, and pet Tortoise ironically named Turbo.

Comments

  1. “If this strikes a chord with you — congratulations on being in the top 96 percent of earners in the United States!”

    So only 4% of earners in the US make under 127k a year? That seems very wrong.

  2. While the comment about being in the “top 96 percent of earners” is technically still correct, I assume you meant in the 96th percentile, which would be the top 4 percent?

  3. I was under the impression that you could not fund a traditional IRA after you have maxed out your 401(k). If this is true, please advise because it is very interesting to consider.

  4. You mention the traditional IRA as a good way to further stretch pre-tax investments, but if you are earning enough to keep you out of Roth IRAs wouldn’t that also mean you are earning too much to deduct the traditional IRA contribution on your taxes?

  5. @JG – You can still contribute to an IRA after maxing out your 401K up to the limit of $5,000 per year, however, you may not be able to deduct the contributions pre-tax but rather as after-tax contributions.

    @Dan – Yes, you will likely not be able to deduct those IRA contributions from your taxes, but any money invested will still grow tax-deferred.

    • Yes I agree it will grow tax-deferred, but from your article “this is a good way of extending the amount of pre-tax money you can invest while again lowering your tax liabilities.”

      It won’t be pre-tax money nor will it lower your tax liabilitiy. I feel you should revise your statements in the article unless I am misreading this somehow.

    • So the only benefit of a traditional IRA with income above the pre-tax limit (in comparison to just investing) is that you delay paying the taxes until withdrawal? The benefit then would only be realized if your marginal tax rate is lower in retirement than the capital gains rate during working years. Correct?