How to open a supersize Roth IRA

Roth IRAs provide some of the best tax benefits for long-term savers. Money invested in a Roth IRA grows tax-deferred, and all withdrawals after age 59 1/2 are completely tax-free when invested at least five years. Also, Roth IRAs aren’t subject to the minimum distribution requirements that apply to those over age 70 who own other IRAs and retirement accounts.

But not everyone can benefit from a Roth IRA. The rules limit how much you can contribute to one each year ($5,500, and $6,500 for those 50 and older.) And higher-income earners (single over $131,000 and married joint over $193,000), who would benefit the most from a Roth IRA, can’t contribute to one.

That is, until now.

Why a Roth IRA is probably your best bet


A new rule that went into effect earlier this year creates a backdoor way around these restrictions and allows some people to make supersize contributions to a Roth. Even those who earn above the income limits can do it.

Here’s why…

IRS Notice 2014-54 is a new rule that allows participants to rollover the aftertax contributions they made into their 401(k) plan to a Roth IRA. This rule became effective in January and applies retroactively to prior distributions.

Not everyone can use this new rule to supersize their Roth IRA. But those who participate in a 401(k) plan that allows you to make aftertax contributions and the plan allows you to withdraw these contributions each year can take advantage.

Here’s how…

First, top up your 401(k) plan with after-tax contributions. Workers can typically contribute $18,000 from their pretax pay to their 401(k) ($24,000 for workers age 50 and older.) But a lot of 401(k) plans that permit aftertax contributions also allow you to make additional aftertax contributions up to the IRS maximum of $53,000 ($59,000 for ages 50 and older.) So, if you’re 50 or older, contribute $24,000 and your employer match is $6,000, you can make an additional aftertax contribution of $29,000 ($59,000 less the $24,000 and $6,000.)

The next step is to rollover the additional after-tax contributions to a Roth IRA. This works best if you do it right after the extra contributions are made so that they earn little or no earnings. If you take a withdrawal of your aftertax money that has grown in the plan, you’ll also have to withdraw the earnings on them. While withdrawn earnings can be taxable, the rule also allows you to rollover these untaxed earnings to a traditional IRA, and in doing so, that amount won’t be included in your taxable income until withdrawn from the traditional IRA at a later date.

You’ll also need to open a Roth IRA before you do this, so that you’ll be ready to deposit and invest the after-tax money into the new account when it’s distributed.

If this is something you can do, and it makes sense for your situation, run it by your tax and financial adviser before you proceed.

But don’t delay because the Obama administration is proposing legislation that includes reining in this strategy.

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