Are There Roth Options for High-Income Earners?

There are a lot of articles and videos outlining the benefits of Roth IRAs. Because of this, Roth accounts have become popular in recent years. Roth IRAs started in 1997, named after the legislative sponsor, Senator William Roth of Deleware. Roth IRAs and 401(k)s permit you to make contributions with after-tax dollars. In addition, Roth funds are not taxed in retirement if withdrawn according to IRS rules. These rules apply not only to contributions but also to account growth. These traits make Roth IRA accounts an excellent option for those who want to pay taxes on their retirement accounts now rather than in retirement.

Roth Refresher

One of the most significant benefits of a Roth IRA is the ability to make tax-free withdrawals in retirement. Roth IRAs have this characteristic because contributions to Roth IRAs are after-tax. Qualified withdrawals are not subject to federal income tax. Growth in the account over time is also tax-free.

So, individuals who expect taxes to be higher later can pay taxes now and contribute to a Roth IRA. Remember that investment earnings depend on the performance of the underlying investments in the Roth account. These benefits are available assuming you take the money out of the retirement account after age 59 ½ and after the account has been active for five years.

Roth IRA Limitations

There are limitations on who can participate in a Roth IRA. The rule is that an individual's maximum contribution to a Roth IRA is up to $6,500 if under 50 or $7,500 if you are 50+ (for 2023). The issue, however, is that the IRS phases out the maximum amount an individual can contribute based on their Modified Adjusted Gross Income (or AGI). Here is a link to the IRS phase-out table based on income and filing status. 

Roth Options

Backdoor Roth

If a family earns a high income and cannot contribute to a Roth IRA, what can they do? One option is to go the route of a backdoor Roth IRA. A backdoor Roth IRA is not a type of account; it's converting a Traditional IRA or Traditional 401(k) into a Roth account. It sounds simple, but there is more to it than just waving a wand or signing a paper and moving the money to a Roth account. A backdoor Roth is not a way to dodge taxes.

You are still going to need to pay taxes on that money. For example, if you move $50,000 of your Traditional IRA to a Roth IRA, that $50,000 may be part of your annual income. If you go this route, I recommend you work with your CPA to determine the tax implications. If you have a lower-income year than usual, your CPA may help you determine if converting part or all of your traditional IRA or 401(k) to Roth makes sense for you.

Roth 401(k)

Another way to participate in a Roth account is to contribute to your 401(k) as a Roth contribution. Most 401(k)s these days have a Roth contribution option. Roth 401(k) does not have an income limit requiring participants to phase out of eligibility. However, like a Roth IRA, there are maximum contribution limits. The contributions of a Roth 401(k) are another highlight of why Roth 401(k)s can be such a great strategy.

For 2023, the 401(k) contribution limit is $22,500 for those under 50 and $30,000 for those 50+. These maximums don't include the possible employer match. Remember, an employee's contributions can be Roth, but employer matches are like a traditional contribution (taxed once you start withdrawing an income).

One limitation to Roth 401(k) contributions is how your company's 401(k) is designed. For example, if a company does not have a safe harbor 401(k), high-income earners may have some or all of their contributions backed out of the plan if it does not pass specific annual compliance tests.

Roth In‐Plan Conversions

An in-plan conversion is similar to a backdoor Roth. You have your 401(k) provider convert part or all of your pre-tax employee contributions to Roth contributions. Just like the backdoor Roth, you are going to need to take the tax implications into account.

One potential limitation to an in-plan conversion is that your retirement plan may not allow it. Though in-plan conversions are generally permitted, employers must choose to enable it in their plan.

Conclusion

This blog post is an introduction to some options available. It is crucial to utilize the help and advice of financial and tax professionals.

Please set up a consultation if you need help reviewing your Roth options. CUI Wealth Management is in Salt Lake City, Utah. We serve clients in many states. Please see the website footer for a complete list of states we serve.