Five (and a Half) Ways to Get Money Into a Roth IRA (Part 1)

This is Part 1 of a two-part series on how to get money into a Roth IRA.

Alongside the many advantages offered by the Roth IRA, one of the benefits is that there are no less than five legitimate ways to get money into a Roth IRA.  And the trend seems to be that Congress seems to be looking for more ways to encourage people to put their money into the Roth IRA.  While each of the five (and a half) ways to get money into a Roth IRA deserve deeper discussion, this post will focus on giving a high-level overview of the different ways to fatten up your Roth IRA.

Method 1: Regular Roth IRA Contribution
This is the tried-and-true method to get money into a Roth IRA account. As of 2023, an individual can contribute up to $6,500 per tax year, and if they are 50 years old by the end of the year, they can make a catch-up contribution of $1,000 for a total of $7,500. This amount increases to $7,000 in 2024 with the same $1,000 catch-up contribution, for a total of up to $8,000.  In order to make the full amount of regular contribution to a Roth IRA, your modified AGI (MAGI) needs to be under certain thresholds: for single, head-of-household filers: $138,000 in 2023 and $146,000 in 2024. For taxpayers married-filing-jointly, the MAGI limits are $218,000 in 2023 and $230,000 in 2024.  At certain income thresholds above these limits, Roth IRA contribution limits are reduced partly and eliminated within a narrow band of $10,000 – $15,000 differences. For anyone making above the full Roth IRA contribution MAGI limits, it will be much easier to do a backdoor Roth IRA if possible (see Method 3 below).

Method 2: Roth Conversion
The second method way to get money into a Roth IRA is to convert traditional IRA funds into the Roth IRA.  This is a very common technique used by savvy recent and early retirees to build up their Roth IRA accounts before they reach full retirement ages.  The downside of this method is that, while there is no income or amount limit for doing a Roth conversion, a standard Roth conversion will incur ordinary income taxes on every dollar converted.  Even though it doesn’t seem particularly opportune to pay taxes during this process, remembering that this was money that was previously excluded from taxes means that there is no real loss here.  When markets are down, or when your income in a given year is relatively lower, such times may prove to be good for doing Roth Conversions. 

Method 3: Backdoor Roth IRA
In terms of pure mechanics of how it’s done, this method is no different than a straight-up Roth conversion. The key differences are, however, in the nature of the money converted, and the tax implications of this technique.  Whereas a Roth conversion simply takes any money from a traditional-type of IRA and moves it into a Roth IRA, a well-executed Backdoor Roth IRA specifically converts just a nondeductible IRA contribution into the Roth IRA.  If done correctly, this method generates no additional taxes and can be treated after 5 years as basis, which allows tax-free and penalty-free withdrawals, even before you reach age 59.5.  The greatest benefit, however, is that it makes Roth IRA accessible to people who make too high of an income to receive a deduction for a traditional IRA contribution and are phased out of a regular Roth IRA contribution income limit.  But there are some pitfalls such as mixing taxable and nontaxable money, which essentially mixes up the basis money such that some portion of the conversion is always taxed.  In my experience, a lot of people read about the Backdoor Roth IRA and unwittingly create this messy situation.  So, my recommendation is to check in with a qualified professional before proceeding, if you have any pretax IRAs.  Ingeniq Capital can definitely help here, because in fact this is an area in which it requires both financial planning knowledge and tax preparation knowledge. Unfortunately, we see mistakes here made more often than we’d like, even with people who have consulted tax professionals. This is usually not because the tax forms are done wrong; it’s because tax professionals aren’t familiar with how to actually avoid pro rata distributions, which is a financial advisory technique.

(continued in Part 2)