One of the things that I see trip-up retiring military officers is the income limits on Roth IRA contributions. As of this writing (2019), if you are married and file jointly the income limit is $203,000 (AGI) and the ability to contribute starts to phase out at $193,000. If you’re single the limit is $137,000 and the phase out begins at $122,000 of AGI. As a reminder, your AGI includes your military retirement. But I’m not going to talk about that today. I’m going to talk about a way you might try to get around it.
Backdoor Roth IRA Conversions aren’t Simple
The backdoor Roth conversion is a way you can get around the income limits listed above. What you do is contribute to a Traditional IRA. Since many of you will have a retirement plan at work your contributions to the Traditional IRA will not be tax deductible as the limits for deducting contributions are the same as the limits for contributions to a Roth. You then convert the Traditional IRA into a Roth IRA. Since the contributions will be with after-tax dollars, there will be little or no taxes due. Great idea.
You Only Have One IRA
What most people don’t understand it that the “A” in IRA doesn’t stand for Account. It stands for Arrangement and an IRA can hold many accounts. There in lies the problem. When you do a Roth conversion you must determine the amount of tax due from the conversion by including all the accounts inside your IRA. Let’s take a look at an example.
- You retire from the military
- When you retire you roll your $294,000 TSP balance to a Traditional IRA
- You’re a savvy guy or gal and you know about the income limits for Roth IRA contributions
- You open up another Traditional IRA account and make a non-deductible $6,000 contribution
- You convert the $6,000 to a Roth IRA
- You assume the conversion is tax-free
- You’re wrong
The calculation for taxes works as follows
- Your total Traditional IRA balance is $300,000
- Of the $300,000, $6,000 are after-tax dollars. This amounts to 2% of the total IRA balance
- The $6,000 conversion is 98% pre-tax dollars and 2% after-tax dollars
- $5,880 will be taxable subject to tax at ordinary tax rates
Nothing is Simple in the Tax Code
Taxes are complicated. When combined with the unique benefits retired military officers earn, they don’t get any simpler. If you’re looking for a financial planner or financial advisor, make sure they understand your military retirement benefits.
If you liked this article, you might enjoy the following blog posts: