Outside of a workplace 401(k) plan that offers a company match, a Roth IRA is money expert Clark Howard’s favorite retirement investment vehicle.
Clark thinks tax rates will increase in the future. If Clark is right, for most people, paying taxes now (Roth IRA) vs. when you withdraw in retirement (traditional IRA) will help you save more money.
However, not everyone is eligible to contribute to a Roth IRA. There are income limits. For 2024, single filers making more than $161,000 and married couples filing jointly and making more than $240,000 are ineligible to make Roth contributions.
Of course, time in the market often trumps timing the market. In other words, many people want to maximize the total time of every dollar invested. Contributing the maximum of $7,000 in January 2024 vs. December 2024 gives you an extra 11 months for your investments to grow, as an example.
But what if you’re unsure whether you’ll be income-eligible for a Roth IRA? What should you do then?
I’m Unclear About My Roth IRA Eligibility for 2024 Due to My Income. Should I Wait To Contribute?
I’m not sure whether I’ll make too much money to contribute to a Roth IRA in 2024. What should I do?
That’s what a listener recently asked Clark.
Asked Katie in Florida: “I generally contribute the maximum ($7,000 in 2024) to my Roth IRA the first week in January to get the biggest benefit. However, I am in line for a promotion at work that if received will bump me just over the income cap to contribute to a Roth. I won’t find out about the promotion until February or March.
“Should I hold off on my contribution until I know what my income will be? I could temporarily keep the funds in my high-yield savings account. If I am not able to contribute to the Roth should I put these funds in a traditional IRA?”
If you contribute to a Roth IRA and later discover you were not eligible to do so based on your MAGI (modified adjusted gross income), you’ll need to withdraw every dollar you contributed. You’ll also need to withdraw any investment earnings you made on those dollars. And then you’ll need to pay income tax on those earnings.
You’ll owe the IRS a 6% penalty for the excess amount you contributed. And you’ll owe that penalty every year for up to six years until you correct your mistake. That means on $7,000 in contributions you weren’t eligible to make, you could pay a maximum of $2,520 in penalties.
Avoid Contributing To a Roth IRA Until You’re Sure You’re Eligible
It’s better to avoid the headache of withdrawing all the money you contributed, calculating the earnings you made on those contributions and figuring those earnings into your income tax.
“First, congratulations on the prospect of your upcoming promotion,” Clark says. “Second, I know you’re a creature of habit. I can tell by the question.
“You want to wait to [contribute] until it’s clear if the income you’re going to earn will put you over the limit to do a Roth. Now remember, it’s based on your adjusted gross income, not your stated paycheck.
“But in this case, it’s better to leave the money in your high-yield savings account. Wait to find out if when the dust clears, if you are still eligible to do the Roth.”
The best high-yield savings accounts are paying 5% APY right now. That’s not a bad consolation prize while you wait to figure out your income.
As an aside, you can make 2023 Roth IRA contributions until April 15, 2024 (Tax Day). That’s always the case. In other words, you can make contributions to an IRA for the previous year through Tax Day of the following year.
Where To Put Your Investment Dollars if Not in a Roth IRA
Let’s say that your income negates your Roth IRA eligibility. And you’ve either maxed out your 401(k) contributions or you don’t have a workplace retirement plan.
Where do you put the money you would’ve contributed to your IRA?
“What I would recommend with that money is that you open an account with Vanguard or Fidelity and put the money in the total stock market index fund at either,” Clark says. “In Fidelity that would be a Fidelity Zero fund with no management fees at all. At Vanguard it’s so cheap anyway it’s like it has no cost.”
There’s another way to filter dollars into a Roth IRA. It’s called a backdoor Roth IRA. Also known as a nondeductible IRA, Clark describes it as “more complicated.” It involves contributing to a traditional IRA, but without the income tax deduction. And then transferring that money into a Roth IRA (and immediately paying taxes on those dollars).
“You can read a briefing on that and see if it’ll fit your situation and you’re willing to go through the extra steps to be able to do what’s known as the backdoor Roth,” Clark says. “Because even when you’re income ineligible, you’re still able with a little extra work to do a Roth contribution each year.”
The IRS won’t recruit a SWAT team to batter down your front door with guns drawn if you accidentally contribute to a Roth IRA in a year in which you aren’t income-eligible.
Still, it’s better to avoid the headache of having to reverse such contributions. If you’re not sure whether you’ll be income eligible, just wait to contribute until you know for sure.