By Andy Ives, CFP®, AIF®
Roth IRAs and Roth 401(k) plans are incredibly popular, and why wouldn’t they be? Both offer tax-free earnings and allow the account owner to pass tax-free dollars to their beneficiaries. However, despite the ubiquity of Roth accounts, there are some common misunderstandings about how Roth IRAs and Roth 401(k)s operate and interact with each other. Confusion swirls around such basic concepts as contribution limits, eligibility and Roth rollovers.
For example, income limits apply to Roth IRA contributions only There are no income limits for designated Roth 401(k) plan salary deferrals. Contributions are the initial building block of Roth IRAs. If a person is otherwise eligible to contribute to a Roth IRA, the maximum amount allowable for 2019 is $6,000 with an extra $1,000 catch-up provision for those who are age 50 or older by year end.
A 2019 Roth IRA contribution can be made up to the tax filing due date, April 15, 2020. There is no extension beyond that date, regardless of whether an extension is filed for the tax return. However, if you make too much money, you are ineligible to contribute directly to a Roth IRA. [Again, we are speaking of Roth IRAs only, not designated Roth 401(k) plans.]
How much is too much? 2019 Roth IRA modified adjusted gross income limits for contributions are as follows:
Married, Filing Joint $193,000 – $203,000
Single or Head of Household $122,000 – $137,000
Married, Filing Separate $0 – $10,000
Example – Tim, age 50, has a modified adjusted gross income of $250,000, which means he is ineligible to contribute directly to a Roth IRA. However, Tim can make salary deferrals to the designated Roth component of his 401(k) despite his high salary because there are no income limits on a Roth 401(k).
Tim desperately wants to participate in a Roth IRA, but understands he makes too much money. He is right – he does make too much to contribute directly to a Roth. However, Tim has a savvy financial advisor. Tim’s advisor suggests the Backdoor Roth strategy. Participation in a traditional IRA is not limited by income. Tim contributes $6,000 of non-deductible money to a traditional IRA and immediately converts those dollars to a Roth IRA. This is a way around the Roth IRA income phase-out limits and, per IRS guidance, is an acceptable way for Tim to use the contribution and conversion rules in his favor.
One final item to be aware of when it comes to the interaction between Roth IRAs and Roth 401(k) plans: rollovers. While Roth 401(k) dollars can be rolled into a Roth IRA, the opposite cannot be done. Roth IRAs are not allowed to be rolled into a Roth 401(k). This is a universal rule and applies to all 401(k) plans. They are simply not allowed to accept Roth IRA dollars.