What’s a Backdoor Roth Conversion and Is It Right For You?
Taxes are coming due and it's the last chance to make some changes before you have to file.
Tax season may be looming, but it’s not too late to make retirement fund contributions for 2021 that can provide you with some relief when it comes time to file your taxes. You have until April 15th to make contributions to your IRA that count for 2021 and can help bring down your adjusted gross income.
If you’re a high networth individual, you may find that a backdoor Roth IRA is a way for you to reap the tax benefits of a Roth IRA while eluding the strict income limits set on this type of account.
What is a backdoor Roth IRA? Keep reading to find out.
What is a Backdoor Roth IRA?
Even though it sounds like a type of retirement savings account, a backdoor Roth IRA is actually a maneuver that allows people who surpass the Roth IRA income limit to still make contributions to a Roth IRA. How is this allowed?
In 2010 Congress took away the $100,000 income limit placed on IRA conversions. This decision makes it so that anyone can contribute funds to a traditional IRA (which doesn’t come with income limits) and then they can convert those traditional IRA savings into a Roth IRA. This workaround is why this maneuver is called a backdoor Roth IRA.
How to Set Up a Backdoor Roth IRA
The process of setting up a backdoor Roth IRA is relatively simple as all you have to do is set up a traditional IRA to get started, which is something that we can help you with.
After you make a contribution to your traditional IRA, you can transfer the assets held in that traditional IRA to a Roth IRA. Generally, we suggest converting funds quickly to avoid letting the funds in the traditional IRA appreciate in value which can increase the amount of taxes you will owe. We can walk you through the steps required to convert funds from a traditional IRA into a Roth IRA.
What to Keep In Mind
While the backdoor Roth IRA process can be a great way to tap into the benefits of a Roth IRA once you make too much money to contribute directly to one, it’s important to be ready to manage the tax implications of this move. Calculating how much you will owe in taxes post-conversion can be tricky as contributing to a Roth IRA (even indirectly) can trigger income tax on the appreciation of your after-tax contributions. Generally, it’s better to convert sooner rather than later to avoid letting the traditional IRA contributions appreciate in value too much.
Not sure if a backdoor Roth IRA is the right move for you? Connect with us to see how we can guide you through your options!