Backdoor Roth

Many people with an above average income level get engrossed in the idea that although they earn a substantial amount, contributing to their Roth IRA is not only unnecessary but very difficult to do. But like many other seemingly daunting processes, there are loopholes for those high income individuals scared to take on the dreaded Roth. It just takes a couple extra maneuvers… 

Let me introduce to you the Backdoor Roth IRA. In this specific type of retirement strategy, there are a couple steps to follow: 

Step 1: Make a nondeductible contribution to a Roth IRA.

• There are no limits to contributing to a traditional IRA, so those who make a high enough income can make a nondeductible contribution to a traditional IRA without age limitations 

Step 2: Convert the traditional IRA into a Roth IRA

• After contributing non deductibles, the individual can convert that traditional IRA into a Roth IRA since there are no income limitations involved with the conversion, so essentially anyone can make the switch from Traditional to Roth

Step 3: Beware of taxation

• The Pro-Rata Rule

• If you have a total balance of $7,000 in pre-tax funds across all your traditional IRAs and you contribute $7,000 as a nondeductible contribution to perform a backdoor Roth IRA conversion, the pro-rata rule would apply. This rule calculates the proportion of pre-tax and after-tax funds in all your traditional IRAs.

• $7,000 (total pre-tax funds) / $14,000 (total balance, including after-tax contribution) = 0.5 or 50%.

• Consequently, when you convert the $7,000 nondeductible contribution to a Roth IRA, only 50% of it, which is $3,500, would be considered after-tax and thus tax-free. The remaining 50% or $3,500 would be taxable.

• Report all contributions to your own form 8606.

It is important to understand the actual number limitations of this exception. If you make under $146k as an individual or $230k between you and a spouse in 2024, the rule states that you are able to make contributions to a regular Roth IRA. If you are earning more than that, then the Backdoor Roth IRA is for you!

There is other news - In 2024, you can now make contributions up to $7,000 by April 15th of 2024, as opposed to $6,500 in 2023. But, if you’re over the age of 50, you can contribute an extra $1,000, which may seem small but can be a big advantage long term. 

All in all, this rule can ultimately make your life much easier when trying to plan for your future. Debunk the myth that high income earners don’t have a way of contributing to an IRA and start understanding the ins and outs in order to not fall behind financially. If you have any other questions about how to utilize the backdoor Roth or anything else similar, please feel free to call or email at (615) 844-3398 or Jim.Maddux@raymondjames.com.

Disclosure: 

Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.