The Michigan Elder Law Blog

Many high income earners believe that they cannot contribute to a Roth IRA.  This is because they are unaware of the loophole they can use by contributing through the backdoor.

The income limitations imposed by the Internal Revenue Service create the perceived barrier.  For 2017, the income and contribution limits for a Roth IRA are as follows:

Filing Status	Modified Adjusted Gross Income	Contribution Limit
Married, Filing Jointly	<$186,000	Up to the limit*
	≥ $186,000, but less than $196,000	Phased Out Amount
	≥$196,000	Ineligible
Married, Filing Separately (lived with spouse during the year)	<$10,000	A reduced amount
	≥10,000	Ineligible to contribute
Single, Head of Household, Married Filing Separately (did not live with spouse at any time during the year)	<$118,000	Up to the limit*
	≥$118,000, but less than $133,000	Phased Out Amount
	≥$133,000	Ineligible to Contribute

Despite the flurry of recent tax legislation, the income limits have remained in place for contributions to a Roth IRA.  However, for conversions from a Traditional IRA to a Roth IRA, the  removed these income limits, creating a backdoor for interested investors to utilize.  To contribute to a Roth IRA through the backdoor, follow these steps:

Step 1: Consult with a tax adviser to determine whether a Roth IRA is an appropriate retirement vehicle for you.

Step 2: Contribute to a non-deductible, Traditional IRA up to the contribution limit.

Your contribution will most likely be non-deductible given the income limits, however, contributions to a Roth IRA are not tax deductible anyway.

Your contribution will be your “cost basis” for tax purposes.

Step 3: Convert your Traditional IRA to a Roth IRA. 

This process will be much easier if both your Traditional IRA and Roth IRA are held with the same custodian.

Do not confuse “conversion” with “distribution,” the latter of which could subject you to a 10% penalty if you are under age 59½ and receive more than the amount of your non-deductible contributions.

The amount of the conversion will be limited to the $5,500.00 (or $6,500.00, if over age 50) assuming that a new Traditional IRA is being opened just for this purpose.

If you are converting an existing Traditional IRA, the limit will be the balance of the account.  Keep in mind, however, that the amount of the conversion will have to be reported to the IRS as ordinary income, so it may be best to convert smaller portions of the existing Traditional IRA over a number of years.

In determining whether it would be better to convert smaller portions of a Traditional IRA over a number of years, consideration should be given to whether the amount of the conversion will bump you up to a higher tax bracket.

More likely than not, if requested, your custodian will leave one penny in your Traditional IRA account so that this process can be repeated every year.  (Be sure to ask if interested.)

If you deposit money into your Traditional IRA in increments, it is usually best to wait and covert the entire amount at one time.

Seek the advice of a tax advisor if you have more than one Traditional IRA (with deductible contributions) because of the “IRA Aggregation Rule” under IRC §408(d)(2).

Step 4: Make note of any income tax due as a result of the conversion to the Roth IRA.

The income tax due will be zero or close to zero if the non-deductible deposit into the Traditional IRA is followed by an immediate conversion into a Roth IRA.

If the conversion results in a higher tax bracket, or more income tax due than your budget allows, then work with your custodian to reverse the process by the October 15^th deadline.

Step 5: Notify the Internal Revenue Service. 

Make sure that IRS Form 8606 is filed with the income tax return for each year that a backdoor Roth IRA contribution is made, in order to alert the IRS that the deposit into the Traditional IRA is non-deductible.  This will also help maintain records of the cost basis/amount of contibutions.

Roth 401(k) Plans Offered through Employer

For those who have access to a Roth 401(k) Plan through work, this could be a viable alternative – or addition to the Roth IRA.  Roth 401(k)’s have no income limits, but for 2017, the contribution limit is the same as for a regular 401(k) – $18,000 ($24,000 if age 50 or over).  Contributions can be made to both a Roth 401(k) and a regular 401(k) in the same year, so long as the contribution does not exceed the $18,000/$24,000 limit.

The most noteworthy distinction between a Roth IRA and a Roth 401(k), is that the Roth 401(k) is subject to the same minimum distribution rules as a traditional or regular 401(k).  Of the three vehicles, the Roth IRA offers the most flexibility in retirement, although contributions are more difficult during the accumulation years for high income earners.  The chart on page 3 can provide assistance in determining whether a Roth IRA, Roth 401(k), or a traditional or regular 401(k) is the best option for your particular situation.

	Designated Roth 401(k) Account	Roth IRA	Traditional, Pre-Tax 401(k) Account
Contributions	Designated Roth employee elective contributions are made with after-tax dollars.	Roth IRA contributions are made with after-tax dollars.	Traditional, pre-tax employee elective contributions are made with before-tax dollars.
Income Limits	No income limitation to participate.	Income limits: • 2017- modified AGI married $196,000/ single $133,000.	No income limitation to participate.
Maximum Elective Contribution	Aggregate employee elective contributions limited to $18,000 in 2017 plus an additional $6,000 for employees age 50 or over.	Contribution limited to $5,500 for 2017, plus an additional $1,000 for employees age 50 or over ($6,500).	Same aggregate limit as Designated Roth 401(k) Account
Taxation of Withdrawals	Withdrawals of contributions and earnings are not taxed provided it’s a qualified distribution – the account is held for at least 5 years and made: • On account of disability, • On or after death, or • On or after attainment of age 59½.	Same as Designated Roth 401(k) Account and can have a qualified distribution for a first time home purchase.  Note: • Contributions (direct) may be withdrawn anytime, without tax or penalty (make sure a record is kept of contributions). • Conversions may be withdrawn without tax (and without penalty, but only if held for 5 years).	Withdrawals of contributions and earnings are subject to Federal and most State income taxes.
Required Distributions	Distributions must begin no later than age 70½, unless still working and not a 5% owner.	No requirement to start taking distributions while owner is alive.	Same as Designated Roth 401(k) Account.
* Source:  Internal Revenue Service.  This article is not intended to provide tax advice.  A tax advisor should be consulted when making a contribution, conversion or withdrawal from any retirement vehicle.

Linda Davis Friedland is an attorney in the Livonia office of Cummings, McClorey, Davis & Acho, P.L.C. where she concentrates her practice on elder law, guardianships, conservatorships, wills, trusts, estate planning, probate administration, trust administration, and litigation in probate court. She also handles matters involving business law, business succession planning, commercial litigation (UCC), contract disputes, shareholder disputes, employment and labor law. As part of her business law practice, she defends creditors against lawsuits filed by aggressive bankruptcy trustees. She may be reached at (734) 261-2400 or lfriedland@cmda-law.com.