It’s never too soon to start saving for your retirement. One of the best ways to do so is to sock money into a Roth IRA account. Unfortunately, higher income people haven’t been allowed to use Roth IRAs because of tax law restrictions. By using the “back-door” Roth-IRA strategy, you can take advantage of a Roth IRA no matter how much money you earn.

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What’s a Roth IRA?

“IRA” is short for Individual Retirement Arrangement. There are two types of IRAs: traditional IRAs and Roth IRAs. You set up whichever IRA you choose with a bank, mutual fund, or other financial institution. You can put in up to $5,500 each year; $6,500 if you’re over 50.

You can double these amounts if you’re married. You can invest the money in your account in just about anything you want. The money you contribute to an IRA grows tax-free.

With a traditional IRA, you get to deduct from your taxes the money you put in each year. You then pay regular income taxes when you take the money out after age 59 1/2.

With a Roth IRA, you get no deduction for your contributions. But when you take your money out, you pay no taxes at all. That’s right, all your withdrawals from a Roth IRA are completely tax-free so long as you had your Roth account for at least five years. You can withdraw as much as you want each year after age 59 1/2. Or, you can take out nothing at all and leave the money to your family or other heirs when you die.

Roth IRAs are a great deal. In fact, they’re so good that Congress restricted them to people who don’t make too much money. The ability to make Roth IRA contributions is phased out if your adjusted gross income is over the amounts shown in this chart:

2018 Phase-Out Ranges for Roth IRA Contributions

Single, Head of HouseholdMarried, filing jointlyMarried, filing separately
$120,000 to $135,000$189,000 to $199,000$0 to $10,000

So, if you’re single, you are not allowed to contribute to a Roth IRA if your AGI is over $135,000. The same goes if you’re married, file a joint return, and your AGI is over $199,000.

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The back-door strategy

Fortunately, there is a way higher-income taxpayers can contribute to a ROTH IRA. All you have to do is set up a traditional IRA and put money in each year up to the annual limits. However, you don’t take a tax deduction for your contributions because your income is too high. This is called a nondeductible IRA and is allowed.

Then, any time in the future, you can transfer the money from your traditional IRA to a Roth IRA. There is no limit on how much money you can move each year. And there are no income limits on the ability to make such a Roth conversion.

When you do such a transfer from a traditional to a Roth IRA, you’ll have to pay income tax on all the money you earned on your contributions to the traditional IRA. If you have old IRAs for which you deducted your contributions, you’ll have to pay tax on those contributions.

But, once your money is in your Roth IRA, all your future earnings will be tax-free. All the money you take out after age 59 ½ will be tax-free as well, provided you had the account for at least five years.

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Is this kosher?

This strategy is called a “back-door” Roth IRA because you get a Roth by first setting up a traditional IRA. It’s been around since 2010. But, up to now, it has been unclear whether the back-door Roth would pass muster with the IRS. Some tax experts cautioned the IRS might prohibit this strategy. However, IRS officials have recently said that the back-door Roth IRA is allowed. This is good news for higher income people who want to save for retirement.

For more information on Roth IRAs, see IRS Publication 590-A, Contributions to Individual Retirement Arrangements.

Stephen Fishman

Stephen Fishman

Stephen Fishman is a self-employed tax expert and regular contributor to MileIQ. He has dedicated his career as an attorney and author to writing useful, authoritative and recognized guides on taxes and business law for entrepreneurs, independent contractors, freelancers and other self-employed people. He is the author of over 20 books and hundreds of articles, and has been quoted in The New York Times, Wall Street Journal, Chicago Tribune, and many other publications. Visit Fishman Law and Tax Files for more information on his work.
Stephen Fishman