How To Use A Roth IRA – Even If Your Income Is Too High [EPISODE #237]
Want to contribute to a Roth IRA, but your income is too high? Never fear, my friends… a solution is here! I’m Bryan Ellis. I’ll give you that solution right now in Episode #237 of Self Directed Investor Talk.
Hello, SDI Nation! Welcome to the broadcast of record for savvy self-directed investors like you, where each day we educate, entertain and INSPIRE you to DECLARE INDEPENDENCE from Wall Street… and in the place of simply DEFAULTING to stocks, bonds and mutual funds, you open your mind and portfolio to alternative assets that are SIMPLE, SAFE and STRONG!
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You want to contribute to an IRA, and you want the best tax benefits possible, which arguably come from the Roth IRA. Problem is, you make too much money. That’s right… the US congress, in its constant state of trying to punish the successful, instituted an income limitation such that you can’t even contribute to a Roth IRA if you make somewhere around $118,000 per year if you’re single or about $186,000 per year if you’re married.
But fear not, SDI Nation! There is a solution!
It’s called the Backdoor Roth IRA, and the basic idea is that:
While there’s an income limit for CONTRIBUTING to a Roth IRA, there’s no income limit for CONVERTING to a Roth IRA. So here’s how we take advantage of this loophole in a most advantageous of manners to give you, my high-income-earning listener, the ability to contribute to a Roth just like your lower-income brethren.
STEP 1: Open a TRADITIONAL IRA – yes, I said “traditional”, not Roth – and make your deposit into that account. But here’s the thing: You can’t take a tax deduction for that contribution. You’ll be doing what’s called a non-deductible contribution. And that’s important in…
STEP 2: This is where you convert that Traditional IRA into a Roth IRA. Voila! Now you’ve got a Roth IRA, just as if you’d put money there in the first place.
Yes, that’s all there is to it, conceptually. It’s a simple 2-step maneuver that effectively eliminates the income limits for Roth IRA contributions.
Now I’ll go ahead and warn you: There are some people out there who criticize this strategy, even suggesting that it’s illegal. That’s a hard case to make since Congress actually REMOVED the income limits for Roth conversions back in 2010, so from the vantage point of this incredibly well-informed layman who is still, in the interest of full disclosure, NOT a lawyer, I think it’s darn near impossible to argue that this is illegal.
But there are 2 red flags to keep your eye on:
Red Flag #1: If you have any money in a traditional IRA at the present time, you might have a bit of a hiccup using this back-door Roth IRA strategy due to something called the IRA Aggregation Rule. I won’t weigh you down with the details right now, but if you’re interested, check this out:
And Red Flag #2 is something called the Step Transaction Doctrine. In a nutshell, this is a legal doctrine that says if it’s against the law for you to do a certain thing, then it’s still against the law for you to accomplish that thing even if you can get there by taking intermediate steps that are entirely within the law. The fear is that the IRS may apply that doctrine to the backdoor Roth IRA strategy.
How do you address that risk? My gut sense, as a non-lawyer who is wholly unqualified to give legal advice, is that it’s wildly improbable that the IRS would pursue that path. Attacking retirement accounts en masse is a real hot button issue for them… there was a situation that arose a few years ago where the IRS could have EASILY pursued tens of millions of IRA’s of all types – not just self-directed IRA’s – for a particular kind of prohibited transaction, and they simply passed on the chance to do it… I think because it would never fly politically. But that’s just my opinion of course, incredibly insightful though it is. <g>
So my advice: Yes, you should seriously consider the backdoor Roth IRA if you want to contribute to a Roth but your income is too high. But before you do that, be sure to talk to an attorney who is an expert in the area of self directed IRA’s. If you don’t have such an attorney, there’s one I recommend highly, and you can get his information right here.
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My friends… invest wisely today, and live well forever!
Bryan Ellis is host of Self Directed Investor Talk, America's #1 radio show and podcast for affluent self-directed investors. He's also an expert in self-directed IRA's, solo 401k's and turnkey rental property investing... at least, that's what his wife tells him 🙂 He's a contributor to well-respected publications like TheStreet.com, Entrepreneur and ThinkRealty. Bryan lives in metro Atlanta, Georgia with Carole Ellis - his wife, business partner and best friend - and his 4 children ranging in age from 2 to 19.