How to Sneak Into a Roth IRA: A Loophole for Higher Earners

Roth IRAIf you're trying to save for retirement, a Roth IRA could be one of your most powerful tools. But if you're a high earner, then until recently, you wouldn't have been able to take advantage of these retirement accounts.

Now, though, there's a little-known way you can get the benefits of a Roth IRA even if you earn more than the income limit. It takes a little extra work, but over time, it can result in thousands of dollars in saved taxes for you.

Most people who use IRAs to save for retirement are more familiar with the Traditional IRA. Those let you take a tax deduction for the money you contribute to your account, giving you an instant tax break that can earn you a bigger refund in the short term. Best of all, although time's running out, you can still make an IRA contribution for 2011 -- that's right, it's for last year -- as long as you get your money in by Tuesday's tax-filing deadline.

Roth IRAs, on the other hand, don't give you a deduction up front, so they aren't as popular. What Roths do give you is tax-free growth for your IRA. So you won't have to pay any taxes on the money when you take it out of your Roth -- unlike a traditional IRA, for which withdrawals come with a potentially heavy tax burden.

What If You Make Too Much?

The problem that some taxpayers run into with Roth IRAs is that there are income limits preventing some people from making contributions. If you were single and made more than $107,000 in 2011 -- or more than $169,000 for joint filers -- then you aren't allowed to make a full contribution to a Roth IRA.

But thanks to another tax law, you can sneak into a Roth IRA through a two-step process. First, you open a Traditional IRA. Then, you can convert those contributed funds into a Roth.

This loophole works because of a 2010 tax law change that eliminated income limits on Roth conversions. Because anyone can now convert from a traditional IRA regardless of income, Roth IRAs are now available to everyone. And if you play your cards right, then the tax impact can be exactly the same as if you simply contributed directly to a Roth in the first place.

The time-sensitive part of this strategy is getting your money into the IRA before the deadline. If you succeed in doing that, then you don't have to get the actual Roth conversion done until after April 17.

Be Careful

Before you use this strategy, though, you have to be aware of some potential complications. The biggest comes if you have other Traditional IRAs for which you took deductions in previous years. If you do a Roth conversion, the IRS is going to want some of those deductions back -- and you'll end up having to include at least part of the converted amount as taxable income, potentially boosting your tax bill. Nobody wants to see that, and it usually doesn't make sense even if you have the money to pay it.

But even if you have big Traditional IRAs already, you still may have a viable solution. If you have a 401(k) retirement plan account at work and your employer accepts what's known as a rollover from your IRA into your 401(k), then you should be able to execute the strategy without taking a big tax bite. Still, having to restructure your entire retirement portfolio adds an extra level of complexity that makes it critical that you set things up correctly.

As with all tax matters, consulting with an accountant to make sure this series of moves works in your particular situation is essential. But given the opportunity that a Roth IRA brings to the table, it's worth some extra effort to see if you can sneak in past the IRS and its income limits.

Motley Fool contributor Dan Caplinger has a mix of traditional and Roth retirement accounts. You can follow him on Twitter here.

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One thing to keep in mind is that a 401-k contribution and an IRA contribution reduces your AGI. A Roth 401-k or Roth IRA contribution does not reduce your IRA. You will not only pay more taxes becuase of the contribution not being deductible but you may also loose some credits and other deductions due to your higher AGI. I did not think about this and it cost me more in taxes than what I was expecting.

April 18 2012 at 5:10 PM Report abuse rate up rate down Reply

Better yet take your money and go shopping at and buy some tangible property which may appreciate over time.

April 18 2012 at 11:39 AM Report abuse rate up rate down Reply

I think you are confusing "contribution limits" with income limitations. The contribution limit is how much you can put in each year, and its $6K in 2011. The income limitations affect whether you are eligible to contribute to a Roth IRA in the first place. If you make more than $170K as a married couple, the contribution limit for a Roth IRA is reduced, and if you make more than $183K a year, you cannot contribute directly to a Roth IRA.

What the article is saying is that a change in the tax law now allows people earning more than $183K a year to backdoor into a Roth IRA by first contributing to a traditional IRA, and then converting that IRA to a Roth IRA. Once you do that, the amounts contributed to the IRA would then not be taxed when you withdraw them in retirement.

That said, the attractiveness of these conversions is being dramatically overblown. Yes, its true that Roth IRAs have some features that make them more attractive than traditional IRAs, the key one being the ability to withdraw the money tax-free at any time. However, if you make more than $183K a year, its probable that you have far better vehicles to save for retirement, like 401ks, Keogh plans, etc.

April 17 2012 at 8:28 AM Report abuse rate up rate down Reply

sktn77a....While I am no licensed retirement professional here is what I think the article is encouraging.
IF you contributed into a standard IRA in 2011 (even up to and including April 17,2012). You may be able to transfer that contribution into a ROTH IRA. Benefit between the 2 varieties? Traditional IRA and Roth IRA I believe do have the same contributionl imits. Limits for both have changed over the years. However, traditional is deposit Pre-tax. You pay upon it's growth. ROTH is deposit POST-tax meaning you pay no tax on it's growth. This article implies to me how to make your tradition IRA convert to ROTH based upon when you depositted the funds. Just my guess. And, probably not worth altering your 2011 taxes. It cannot be used for tax years of past. However, consult your tax advisor for clarity.

April 16 2012 at 8:32 PM Report abuse rate up rate down Reply

Arent the traditional IRA income limits the same as the Roth IRA income limits?

April 16 2012 at 6:45 PM Report abuse rate up rate down Reply