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

A Roth IRA is a saver’s best friend.

If you’re single and make more than $135,000 per year or married and jointly make more than $199,000 per year, you are over Roth IRA income limits and are no longer eligible to contribute to a Roth. (2017)

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What originally made a Roth retirement plan so attractive begins to lose its appeal as your earned income rises.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. In 2018, you can contribute up to $18,500. 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 2015.