Do you qualify for a Roth IRA? If you are limited to contributing to a Traditional IRA this year, there is still a way for you to contribute to a Roth IRA. This is especially important if you do not have an IRA established already, or have an existing Roth IRA and are newly ineligible.
In 2010, an important income limit law changed that allowed those making over $100,000 a year to convert traditional IRA’s to Roth IRA’s. This change creates a backdoor into the Roth IRA for those not qualified. I will be going into more detail about Individual Retirement Arrangements (IRA, commonly mistaken as Individual Retirement Account) later for those who are not familiar, but I wanted to get this information out since the end of the year is a few days away. Especially since I’ve been hearing from a lot of high earners who previously thought they were competely disqualified from depositing money into a Roth IRA.
Detailed information regarding IRA’s can be located on the official IRS website. Again, followup information about IRA’s will be coming soon in the investment learning series.
Can You Contribute to a Roth IRA?
Generally, you can contribute to a Roth IRA if you have taxable compensation and your modified AGI is less than:
- $179,000 for married filing jointly or qualifying widow(er),
- $122,000 for single, head of household, or married filing separately and you did not live with your spouse at any time during the year, and
- $10,000 for married filing separately and you lived with your spouse at any time during the year.
– Internal Revenue Service
How To Contribute To A Roth IRA If You Do Not Qualify (How Convert A Traditional IRA to a Roth IRA)
- You have until April 17, 2012 or the day you file your taxes (Otherwise you may have to file an amendment) to use this method to contribute to a Roth IRA indirectly. These steps assume you will be using the same brokerage or bank for your conversion.
- Open a new Traditional IRA at your choice of bank, brokerage, discount brokerage, or with your investment adviser/financial planner.
- Contribute the amount you would like into the Traditional IRA you just opened. The limit for 2011 is $5000.
- At the same time you open your account, open a new Roth IRA. If you already have an existing Roth IRA, skip this step.
- Fill out a Roth IRA conversion form.
- Enter your personal and contact information as the form dictates. Every brokerage or bank has their own forms.
- Under “type of current plan” check off Traditional IRA (the one you just opened and funded) and enter the that account number.
- Select “total conversion.” If there is only a spot to place a dollar amount, write down the amount you contributed. If it was the maximum $5000, enter that number.
- Then choose, “convert into existing Roth IRA” and enter that account number. At your bank or brokerage, they may have an option to convert the new Traditional IRA into a Roth IRA automatically if you do not have an existing account (allowing you to skip step 4 as well).
- In the Federal & Tax Withholding section, select that you do not want any taxes withheld.
- Be sure to sign and date the document and submit it at the same time you open the Traditional IRA or immediately after the contributory funds are deposited.
- It may take a few days after your bank or brokerage processes the forms, but you have now contributed to a Roth IRA by using the conversion method. Congratulations!
Potential Tax Consequences
If you follow the above guide and start a brand new Traditional IRA and convert the entire amount to a Roth IRA, you will owe no taxes. Make sure that you when you file your tax return you do not take any deduction on the Traditional IRA. It is also known as a Non-Deductible IRA, or Non-Deductible Traditional IRA.
However, if you have an existing Traditional IRA that has investment gains in the account, you may have to pay taxes on the conversion. This guide does not cover existing Traditional IRA, total or partial, conversions to a Roth IRA. If you do not have the expertise to properly estimate the potential tax consequences of a conversion, please consult a tax professional, accountant, or financial adviser.