While most people can contribute directly to a Roth IRA, the IRS defines income limits that prevent high income earners from doing just that. Enter the backdoor Roth IRA—a colloquial term for the conversion of a traditional IRA to a Roth IRA which allows high income earners to indirectly fund a Roth individual retirement account.
We all know the awesome benefits of a Roth IRA: money grows tax free and you pay no taxes on it in retirement. It’s no wonder that high income earners are willing to jump through a few hoops to access Roth IRAs. A backdoor Roth IRA essentially allows people with high incomes to avoid Roth IRA contribution limits.
Here is a list of 5 essential backdoor Roth IRA facts that you should know about.
1. A Backdoor Roth IRA is Essentially a Rollover of a Traditional IRA
Simply put, a backdoor Roth IRA is the act of rolling over a traditional IRA to a Roth IRA. While just about anyone with a traditional IRA can execute a backdoor Roth IRA conversion, it makes the most sense for high income earners. You see, the IRS establishesRoth IRA contribution limitsbased on your salary. Those who make over a certain salary are not eligible to contribute directly to a Roth IRA; however, they can fund a Roth IRA using this backdoor method.
2. Roth IRA Contribution Limits Dictate The Need for a Backdoor Roth IRA
Single, head of household, or married filing separately not living with your spouse
Less than $122,000
$6,000
$122,000 to $137,000
Reduced amount*
$137,000 or more
$0
*useIRS Worksheet 2-2to determine your reduced Roth IRA contribution limit
Not everyone needs to fund their Roth IRA through the backdoor method. A backdoor Roth IRA is only necessary for high income earners according to the2019 Roth IRA Contribution Limitstable above. Anyone who has a Roth IRA contribution limit of $0 or a reduced amount can fund a Roth IRA via the backdoor method.
3. Immediately Rollover a Traditional IRA to Roth IRA to Avoid Taxes
In order to minimize taxes, it is recommended that you convert your traditional IRA to a Roth IRA as soon as possible after contributing. Whether you make periodic deposits into a traditional IRA throughout the year or one large lump sum contribution, the sooner you rollover from traditional to Roth, the better.
You must pay tax on any traditional IRA earnings when converting to a Roth IRA. Therefore, it makes sense to fund your Roth IRA through the backdoor method immediately after contributing to your traditional IRA. In other words, rollover your traditional IRA funds to a Roth IRA account right after making any contributions.
Theone-rollover-per-yearrule does not apply to rollovers from traditional IRAs to Roth IRAs meaning you can technically fund your backdoor Roth IRA multiple times per year. Although you have this freedom and flexibility, be sure to convert from traditional to Roth as soon as possible after funding your traditional IRA to avoid paying taxes on any gains.
4. You Have Until April 15, 2020 to Make a 2019 IRA Contribution
Contrary to popular belief, the IRA contribution deadline is April 15th of every year, not December 31st. This means you can make 2019 IRA contributions until April 15, 2020. In other words, you have a total of 15.5 months between January 1, 2019 and April 15, 2020 to contribute to your IRA accounts.
Because there is an extra step of rolling over funds and since you want to avoid paying taxes on gains, it is recommend that you fund your traditional IRA in a lump sum sometime before the April tax deadline and quickly convert theses funds into a Roth IRA via the backdoor method.
5. You Must Have Earned Income to Fund a Backdoor Roth IRA
If you don’t earn any income during the year, you are not eligible to contribute to an IRA. Earned income does not include:
Additionally, if your income is less than the Roth IRA contribution limit, you can only contribute as much as you earn. For example, the Roth IRA contribution limit in 2019 is $6,000. If you only earn $3,500 in 2019, you can contribute at most $3,500 to an IRA.
Although I don’t earn enough money (yet) to need a backdoor Roth IRA, I am still very much interested in this topic and the topic ofretirement savings and investingin general. Do you have a backdoor Roth IRA or planning on contributing to one? I’d love to hear from you in the comments below.
The Roth IRA five-year rule says you cannot withdraw earnings tax-free until it's been at least five years since you first contributed to a Roth IRA account. This five-year rule applies to everyone who contributes to a Roth IRA, whether they're 59 ½ or 105 years old.
The 5-year aging rule applies to inherited Roth IRAs as well, and rules around them can be complicated. To make qualified withdrawals, it must be 5 years since the beginning of the tax year when the original account owner made the initial contribution, even if the new owner is 59½ or older.
Right now, the mega backdoor Roth is not going away as long as your employer plan allows it. That's good news! But it's not permanent news – there could be legislation on the way that eliminates the option to make after-tax contributions.
An IRA is an account set up at a financial institution that allows an individual to save for retirement with tax-free growth or on a tax-deferred basis.
As long as the taxpayer does not hold any pre-tax IRA funds at the end of the year, a backdoor Roth contribution could be executed without having to worry about the pro-rata rule.
You may not need a backdoor Roth conversion if you are able to meet your savings goals with the maximum retirement limit through your workplace retirement account, and are not expecting a need for additional savings.
Roth IRA Income Limits: For 2023, if your MAGI is $153,000 ($161,000 in 2024) or higher and you're single, or $228,000 ($240,000 in 2024) or higher and you're married filing jointly or a qualifying widow or widower, then you can't contribute to a traditional Roth IRA.
The 5-year rule applies to taking distributions from an inherited IRA. To withdraw earnings from an inherited IRA, the account must have been opened for a minimum of five years at the time of death of the original account holder.
A Roth IRA conversion ladder is a multiyear strategy that allows you to tap your retirement account without penalty before reaching age 59½. There's a separate five-year waiting period for each conversion; by doing a conversion every year for several years, you create a “ladder.”
“If you open a Roth IRA for the first time in order to receive Roth 401(k) rollover funds, then you must wait five years to take a distribution penalty-free.” This rule wouldn't prevent you from withdrawing your original contributions after the rollover is complete.
Cons: All or part of a backdoor Roth IRA conversion could be a taxable event. You may have to pay federal, state, and local taxes on converted earnings and deductible contributions. Conversions could kick you into a higher tax bracket for the year.
You won't pay double taxes with a backdoor Roth, but you may end up paying some taxes depending on your financial situation. Talk with your financial advisor before making this move to minimize taxes and maximize retirement benefits.
A backdoor Roth IRA is a conversion that allows high earners to open a Roth IRA despite IRS-imposed income limits. Basically, you put money you've already paid taxes on in a traditional IRA, then convert your contributed money into a Roth IRA, and you're done.
There is no minimum required amount for opening an IRA, and no rules about how much money you must deposit. Note that brokers set their own account minimums, but the requirement is often lower for IRAs versus taxable brokerage accounts. At some brokers, the account minimum for IRAs is $0.
Who is eligible to contribute to a Traditional IRA? Anyone with an earned income and their spouses, if married and filing jointly, can contribute to a Traditional IRA. There is no age limit.
Disclosure statements for retirement plans must clearly spell out who contributes to the plan, contribution limits, penalties, and tax status. Disclosure statement for loans must spell out loan terms, including the annual percentage rate or APR, charges and fees.
Eligibility requirements are low. In general, you're eligible to participate in a SIMPLE IRA if you've received at least $5,000 in compensation during any two preceding calendar years and expect to earn at least that much during the calendar year of participation.
Introduction: My name is Tish Haag, I am a excited, delightful, curious, beautiful, agreeable, enchanting, fancy person who loves writing and wants to share my knowledge and understanding with you.
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