Roths are a powerful federal retirement planning tool! Whether it be your Roth TSP or a Roth IRA, these accounts provide tax-free income in retirement, the opportunity to limit the taxation of your Social Security benefits, and no Required Minimum Distributions, to name a few of the perks.
But not every federal employee is eligible to contribute to one directly, and while Feds can utilize a backdoor Roth strategy, this does add some complexity to your retirement planning.
So, this week we’re covering the nuts and bolts of Roth IRA eligibility.
2023 Roth IRA Contribution Limits
Before we jump into the eligibility rules, let’s review the Roth IRA annual contribution limits for 2023. For folks under 50, the maximum that can be contributed to a Roth IRA this year is $6,500; for those 50 and older, the number increases by $1,000 to $7,500.
Keep in mind that this limit applies to both types of IRAs, traditional and Roth, in aggregate for the year. For example, say Bob is a 25-year-old federal employee and is eligible to contribute to both a traditional and Roth IRA for the year. Although he is contributing enough to his TSP to receive his agency’s full match, he’s a highly motivated saver and has decided to utilize both a traditional and Roth IRA. If he contributes $6,000 to his Roth IRA in 2023, he’ll only be able to contribute $500 to his traditional IRA ($6,500 Maximum Annual Contribution – $6,000 Roth IRA Contribution = $500 of the Maximum Annual Contribution Remaining).
Roth IRA Income Limits
Ok, now that we know how much you can contribute to a Roth IRA, let’s review who’s eligible.
When it comes to Roth IRAs, your income ultimately determines your eligibility. For instance, this tax year (2023), those Feds filing their taxes as single must have a Modified Adjusted Gross Income (MAGI) of less than $153,000, and for those married filing jointly, your joint MAGI must be under $228,000.
Now if your income is under these thresholds but within the phaseout range, you’ll still be able to contribute, but it’ll be a reduced amount. To see the income phase-out ranges, review the table below.
*MAGI is your AGI with certain deductions added back.
Backdoor Roth IRA
What happens if your income exceeds the income limits? As mentioned, if you’re not eligible to contribute to a Roth IRA directly, you can still use a backdoor strategy to get around the rule legally.
This strategy involves either converting an existing traditional IRA or opening an IRA to make nondeductible contributions and then immediately transferring those contributions into a Roth IRA.
The financial institution holding your IRA should be able to help you with the mechanics.
Pro Tip: Ensure you file Form 8606 to report the conversion and any nondeductible contributions when you file your income taxes.
Making Ineligible Contributions
Making ineligible contributions or contributions that exceed the annual maximums can trigger a penalty from the IRS that could easily wipe out any investment income. Ineligible contributions are subject to a 6% penalty for every year it remains in your account, so time is of the essence.
But here’s the good news, you’re allowed to backtrack; depending on when you discover the mistake, you may be able to correct it and avoid the penalty.
Contributing to a Roth IRA is a great way to supercharge your retirement savings and create some tax diversification in your nest egg. But not every federal employee is eligible to save in one, and making ineligible contributions is a surprisingly easy and costly mistake.
So, keeping a close eye on your Modified Adjusted Gross Income is critical as you near the income thresholds. If you become ineligible to contribute directly to a Roth IRA, remember that you can utilize a backdoor Roth strategy to skirt the income rules legally. As always, consult a fee-only CFP® if you’re not confident about creating your retirement plan.
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2023 Legislative Change Notice
The SECURE ACT 2.0 passed and impacted many of the articles on this website. While the articles were correct when written, it’s impossible to re-write every article. Please consult a qualified professional (i.e., CFP®, CPA, or attorney) before implementing any strategy.