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What to Do if You're Creeping Closer to the Roth IRA Income Limit

Going to tip the scales toward going over the Roth IRA income limits? Don't panic. You have options. Let's go over them.

This story originally appeared on MarketBeat

When you're on a company's payroll, it's usually easy to figure out how much you'll make for the year and whether it comes below the Roth IRA income limit threshold. 

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Like it or not, the Internal Revenue Service (IRS) limits contributions to a Roth IRA to prevent highly paid workers from benefiting from specific tax advantages more than the average worker.

What about those not on payroll? Let's say you own your own business and it's going well. You have some income goals but suddenly, it's August and you realize you blew those goals out of the water. You've been contributing to a Roth IRA consistently each month to invest the full $6,000 per year ($7,000 if you're 50 and older). 

Suddenly, you realize that you're bumping close to the limit or will probably go over the limit. (Hey, when business booms, it booms.)

Let's discuss what you should do next.

What is the Income Limit for a Roth IRA in 2021?

First, what is the income limit for a Roth IRA in 2021? 

Single tax filers must have a modified adjusted gross income (MAGI) of $140,000 or less. Those married and filing jointly should have a joint MAGI under $208,000. 

However, it's not as cut-and-dried as that. If you have a MAGI of less than $125,000 as a single filer, you can contribute the full amount. If your MAGI is more than $125,000, but less than $140,000, you can only contribute a reduced amount. 

What Happens if You Go Over the Income Limit for a Roth IRA?

What will actually happen if you go over the income limit? 

If you're not eligible to contribute, you'll pay a 6% excess contribution tax of the amount you contributed to your Roth IRA. In other words, let's say you contribute the full $6,000 when your contribution limit should be $0. In this case, you've contributed $6,000 too much and must owe $360 in penalties. You pay the penalty when you file your income tax return.

You must also withdraw your excess contribution. In other words, let's say your $6,000 grew to $6,300. You would also have to withdraw the $300 in earnings. However, if the Roth IRA had a bad few months and declined by $300 instead, you would withdraw $5,700. 

Talk to an Accountant

Suddenly realized that you've made too much for the year and don't "qualify" to contribute to a Roth IRA? You're going to want to get a tax advisor on your side because you may have to file certain forms with the IRS.

Do you have an accountant? If not, get one soon. As a business owner, you can find many reasons to hire an accountant beyond guiding you through the Roth IRA income limits, including the following: 

  • Getting advice about your company’s legal structure: When you need advice about your company's legal structure (whether you choose to get a limited company, limited liability partnership or corporation or stick to sole proprietorship) an accountant can help you. 
  • Finance help: Losing control of who owes you money and how long ago that was? Hire an accountant. Having someone else handle your finances can also free you up to focus on the core of your business and scaling. In addition, when you're ready to hire help, an accountant can also handle your payroll, employee tax codes and pay get recorded correctly. As your company grows, you need an accountant.
  • Dealing with government paperwork: Beyond tax returns, an accountant can help you navigate legal and compliance documents, understand the latest tax laws and more. You should also have an accountant on hand in case you get audited.

Convinced it's not worth it to fly solo anymore? Great. Ask other business owners in your area who they use so you get the best tax advice you can get.

Your accountant may be able to help you find extra deductions in which to get you under the threshold. Be as upfront with your accountant about your income situation and alert him or hear early on in the year instead of waiting until March (right before taxes are due) to bring this to his or her attention.

Ask about a Backdoor Roth IRA

Have you ever heard of a backdoor Roth IRA? It offers a way for you to fund a Roth as a high-income earner even if your earnings exceed the IRS limits.

Let's go over the ways in which you can make that happen. 

  • Contribute money to an existing traditional IRA. Next, you'll roll over the funds to a Roth IRA account. 
  • Convert your entire traditional IRA account to a Roth IRA account. 
  • Make an after-tax contribution to a 401(k) plan. Next, roll the money over to a Roth IRA. 

Check out the benefits to going this route if you do realize that you've made too much money to contribute to a Roth: 

  • No required minimum distributions (RMDs): You don't have to withdraw money from a Roth by a certain age. Unlike other retirement savings vehicles, you can leave it well past age 72 if you want to. Hello, tax-free growth. 
  • Inheritance benefits galore: Why not leave money to your children or other beneficiaries for after you die?
  • Perfect for higher tax brackets in retirement: If you think you might end up in a higher income tax bracket when you retire, you may want to seriously consider the backdoor Roth.

Check with your tax advisor about the tax implications of a backdoor Roth. As you may have imagined, it's not free.

Creeping Closer? Consult a Tax Professional

Ultimately, you want to make sure you're staying under the Roth IRA income limits, but if you have a business, that might be an easy way you can slip over the limits on accident. 

On the other hand, it's also easy to just not "catch" it after a few salary increases. Check with a tax professional so you know all the options available to you.