The Roth Less Traveled: How High Earners Can Enjoy Lower Tax Bills in Retirement

Photographer: Henrik Sorensen/Getty Images

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Photographer: Henrik Sorensen/Getty Images

Bashing the investment habits of millennials is popular lately, but often misguided. Adding to evidence that the kids may be alright: their embrace of Roth IRAs. Millennials contributed to the accounts twice as often as those age 50 and up, according to the Employee Benefit Research Institute. That may be because more seasoned, highly paid workers think their incomes disqualify them from opening a Roth.

But they don't. Since 2010, anyone, from the CEO to the CEO's admin, can finagle their way into a Roth IRA and its retirement payoff of tax-free withdrawals.

Okay, there's a small catch. This year, anyone with modified adjusted gross income above $129,000, and married couples with joint income topping $191,000, can't fund a Roth IRA directly. Emphasis on "directly." People with income above those limits can fund a non-deductible traditional IRA, then convert it to a Roth. CPAs call this perfectly legal maneuver a back door Roth IRA.

For those who don't have a traditional IRA, doing a Roth IRA is a "no-brainer," says Ed Slott, of irahelp.com. If you already have a traditional IRA, converting may bring a tax bill. If you've been saving in a 401(k) and only a 401(k), you're also a good candidate. Same goes for a couple where only one spouse has money in a traditional IRA. The other spouse can get into a Roth IRA using the back-door strategy without triggering a tax bill.

Related: One of the Best Retirement Deals 9 out of 10 People Ignore

The IRA contribution limit this year is $5,500 per person for those under 50, and $6,500 for those over 50. A married couple that saves $5,500 for 20 years in a Roth, and earns an annualized 5 percent return, will have nearly $400,000 in tax-free money to use in retirement. With a Roth, there's no requirement to start taking minimum distributions at 70 1/2. That comes in handy for those who don't need the money, since it lowers taxable income.

For those with traditional IRAs funded by pre-tax dollars, taking the indirect Roth route changes from being a no-brainer to a maybe. That's because there will be a tax bill in the conversion year.

Say you have $225,000 in a traditional IRA from a rollover. You want to make a $5,500 non-deductible contribution to it and then convert the $5,500 to a Roth. To figure out what you'd owe, divide the $5,500 by $230,500 (the $225,000 plus the new $5,500 to be converted). In this case, only 2.4 percent of the $5,500 will be tax-free. On a $50,000 traditional IRA about 10 percent would be tax-free.

The tradeoff for upfront tax pain is tax-free money for life, provided you wait five years and are 59 1/2 before you touch it. One timely objection: The long market rally means the tax bill could be big. That's true. But waiting to convert also has risks, says Slott: "You're just delaying the inevitable" -- that your retirement savings will be taxed -- at a time when tax rates are near an all-time low.

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