When Roth IRAs were created in 1997, they were an exciting new idea. They provided a way to make after-tax contributions that could, under certain conditions, grow entirely free of federal income taxes.
Prior to that, traditional IRAs worked basically the other way around — you could make deductible contributions, but distributions would be fully taxable. The law also allowed taxpayers to “convert” traditional IRAs to Roth IRAs by paying income taxes on the amount converted.
Roth IRAs represented a great new opportunity for many people, but there were a couple of legal stipulations that prevented higher income earners from taking advantage of them. First, the annual contributions an individual could make to a Roth IRA were reduced or eliminated if their income exceeded certain levels. Second, individuals with incomes of $100,000 or more, whose tax filing status was married filing separately, were prohibited from converting a traditional IRA to a Roth IRA.
But in 2005, Congress passed the Tax Increase Prevention and Reconciliation Act, repealing the second barrier. Starting in 2010, anyone would be allowed to convert a traditional IRA to a Roth IRA, regardless of income level or marital status.
TIPRA did not repeal the first barrier that limited the ability to make annual Roth contributions based on income, but a legal avenue was opened by the removal of the second barrier. Since 2010 it has been possible to make contributions to a traditional IRA, and then convert all or part of the funds to a Roth. (Note: there is one exception — you generally can’t convert an inherited IRA to Roth. Special rules apply to spouse beneficiaries.)
Many high income earners may still be playing by the old familiar rules simply because they are unaware of the new opportunity. The benefits of a Roth IRA are now accessible through a legal “back door.” There are no limits to the number of Roth conversions you can make.
Under the new TIPRA provisions you can also roll funds over from an employer-based plan, like a 401(k), to a Roth IRA
So, if you have not considered a Roth IRA because you thought your income was too high, it’s definitely worth another look. And watch out for next month’s article, where I’ll dig a little deeper and teach how to calculate the conversion tax.
Humphrey G Thomas is an accredit asset management specialist and a certified divorce financial analyst at HG Thomas Wealth Management, LLC. Estate planning is done in conjunction with your estate planning attorney, tax or cps. Contact him at email@example.com or 956-542-6044. For more information, visit www.hgthomas.com.