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In Through the Back Door: What is the Back Door Roth IRA?

Updated: Nov 13, 2022

The Roth IRA has been popular for quite a while now. You have heard about its tax-free benefits and you would like to open one. But, there is a problem - you make too much money.

Don't despair, the door isn't closed. Even though high-income individuals are prevented from contributing directly to a Roth IRA, you can still get in on this popular retirement account by using the backdoor.

While it sounds kind of like a spy novel, it is actually called the "Back Door Roth IRA" strategy. Let's jump in:

First, a Roth IRA Refresher

The Roth IRA is a tax-advantaged account to help you save for your retirement and is funded with after-tax money - so you get no upfront income tax deduction for your contributions.

That's the downside. The upside is that the growth inside the IRA is tax-free, and the income when withdrawn, is also tax-free as long as you meet IRS rules (just don't touch the money until you are 59 1/2 or for 5 years, whichever is longer, and you should be fine).

The 'no upfront tax deduction' is basically a trade-off for tax-free growth and tax-free income later in retirement. Contrast this to a traditional IRA which is tax deferred (i.e. you are putting Uncle Sam on hold until you pay taxes later on all growth).

Here's the challenge for higher income people: If your earned income is too high, you cannot contribute to a Roth IRA.

If you are single and earn more than $144,000 (for 2022), or married filing joint and earn more than $214,000 (for 2022) you cannot contribute to a Roth IRA.

How then can you get contributions into a Roth IRA? By using a Back Door Roth.

In Through the Back Door

You have heard of Roth conversions - this is taking funds from a pre-tax retirement account and "converting" them to an after-tax Roth account.

Just about anyone can do a conversion - there are no income limitations like there are on contributions. But there are taxes, so consult with a financial planner first.

An example of a conversion is when you take funds from a traditional IRA and "convert" them to a Roth IRA. You generally pay taxes on this conversion.

So if your income is too high to contribute to a Roth IRA, a way to get money into one is by conversion. You could make a non-deductible contribution to a traditional IRA. There are no income limitations on non-deductible contributions. You can then convert this over to a Roth IRA.

This can work well if you only have one traditional IRA and just use it for making non-deductible contributions to convert to a Roth IRA. There may be little or no tax on this conversion, as long as you have no other traditional IRAs.

5 Star Tip: If you do have other traditional IRAs (like from a 401k rollover) and attempt this strategy, you will pay taxes on the conversion because of something called the pro-rata rule. Not a deal breaker, but it can get a little tricky. Talk to a financial planner first if you are not sure.

I would recommend you research the pro-rata rule on IRAs before proceeding.

Back Door Steps

So, here is what the Back Door Roth conversion can look like:

  1. Open a traditional and a Roth IRA at the same custodian.

  2. Make a non-deductible contribution to the traditional IRA. There are no income limitations for a non-deductible contribution.

  3. Wait a day or two and then convert the balance from the traditional IRA to the Roth.

  4. Be sure and file form 8606 for non-deductible IRA contributions.

Final Thoughts

Please remember there can be taxes involved, so talk with a financial planner before using this process. Everyone's situation is a little different. I help people and employees from many companies with this planning strategy, so reach out to see if I can help!

John Piershale, CFP®, AEP®

John Piershale Wealth Management, LLC is an Investment Adviser registered with the State of IL and in other jurisdictions where exempt from registration. All views, expressions, and opinions included in this communication are subject to change. This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment

advisory services. Any information provided has been obtained from sources considered reliable, but we do not guarantee the accuracy or the completeness of any description of securities, markets or developments mentioned.

The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.


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