Roth IRAs are popular in part because they’re designed for people who expect to earn more as they move toward retirement. Since you’re taxed when you contribute, and not when you withdraw, the theory is that you’re at a lower tax bracket now than you will be by the time you think about retiring.
So, say you started a Roth IRA and have made regular contributions. Good for you! You get a promotion and a big raise and suddenly, you’re over the income cap for contributing. Also good for you!
What happens now?
Well, nothing. If you don’t contribute, your Roth IRA still earns on your investments, and you can still adjust your allocations as desired.
You’ll just have to do a little retirement savings re-strategizing.
Roth IRA Contribution Limits for 2019
You may know that the contribution limit for Traditional and Roth IRAs for 2019 is $6,000 (or $7,000 if you’re 50 or older). The income cap to contribute to a Roth IRA to the full limit is $122,000 for an individual or $193,000 for a couple. Keep in mind, that’s the modified adjusted gross income, not taxable income.
There’s also a phase-out limit for higher earners. If you’re married and filing taxes jointly with an adjusted gross income of $193,000-$203,000, you can still contribute a portion of the limit. Likewise, if you’re single with an AGI of $122,000-$137,000. The IRS has a phase-out contribution formula to help.
Zuzana Brochu, a CFP based in Burlington, Vermont, said that if you’re unsure of whether you’ll hit the cap, you may want to wait to make a Roth contribution until you do your taxes and confirm your AGI. “That doesn’t mean you shouldn’t be saving or investing throughout the year,” she said. “You just may want to make those contributions to a taxable account until you are sure that you will be Roth eligible in that tax year.”
Over-contributing or dumping money into your Roth without paying attention to the income cap has consequences. Brochu said that if you over-contribute to a Roth IRA, you’ll have to withdraw the excess and any earnings on it. Otherwise, you’ll pay a 6% tax on ineligible contributions, plus you’ll pay a 10% early withdrawal penalty if you’re younger than 59.5.
If you realize you’ve over-contributed, Brochu advised to correct the mistake before the April 15 tax filing deadline to avoid having to go back later and file an amended return.
The Backdoor Roth Method
If you’ve absolutely hit the cap and want to keep investing, you’ll have to open a Traditional IRA: it has the same annual contribution limit as a Roth, but taxes contributions on withdrawal.
Then, if you’re feeling really savvy (and, seriously, have a financial professional on hand to guide you), you can convert money from a traditional IRA to a Roth IRA through what’s called a Backdoor Roth.
As Alicia Adamczyk previously explained:
There are no income limits on conversion. It can happen one of a few ways: You can make nondeductible contributions to a traditional IRA (in other words, you already paid taxes on the contributions), and then convert that account into a Roth, or you can pay taxes on the money when you convert.
There’s no limit on how much money you can convert, but keep in mind that you must leave those funds in your Roth for five years or else owe taxes on the gains. If you’re considering a Backdoor Roth, consult a professional.