Cary Stamp, leading financial advisor based in Jupiter, FL, offers a quick description of how to do a Back Door Roth IRA, which is the method for contributing to a Roth IRA even if you earn too much income….(read more)

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How To Do the Backdoor Roth IRA

The Backdoor Roth IRA is a strategy that allows individuals with high incomes to contribute to a Roth IRA, even if they are not eligible to do so directly. This method involves making a nondeductible traditional IRA contribution and then converting it to a Roth IRA. While it sounds complicated, it is actually a fairly straightforward process. In this article, we will guide you through the steps to execute a Backdoor Roth IRA.

Step 1 – Check your eligibility:
First, you need to ensure that you are not eligible to contribute directly to a Roth IRA due to exceeding the income limits. For single filers in 2022, the phase-out begins at a modified adjusted gross income (MAGI) of $125,000 and is completely phased out at $140,000. For married couples filing jointly, the phase-out starts at $198,000 and is fully phased out at $208,000. If your income exceeds these limits, you are a good candidate for the Backdoor Roth IRA.

Step 2 – Open a traditional IRA account:
If you don’t already have a traditional IRA account, you will need to open one with a financial institution of your choice. Make sure to opt for a traditional IRA, not a Roth IRA, since you will be making a conversion later on. Take note that there may be minimum opening deposit requirements set by the institution.

Step 3 – Make a nondeductible contribution:
Once your traditional IRA account is open, make a nondeductible contribution to it. The contribution limit for individuals under 50 years is $6,000 in 2022, while those 50 and older can contribute an additional catch-up amount of $1,000. Ensuring your contribution is nondeductible is essential, as a deductible contribution would create taxable income upon conversion.

Step 4 – Convert the traditional IRA to a Roth IRA:
After making the nondeductible contribution, you will need to convert the traditional IRA into a Roth IRA. Contact your financial institution and request a Roth IRA conversion. They will guide you through the process, which usually involves completing some paperwork and specifying the amount you want to convert.

Step 5 – Pay taxes, if applicable:
Since the original contribution was made on an after-tax basis, the conversion generally does not result in any taxes owed. However, suppose you had any deductible contributions, earnings, or gains on investments in your traditional IRA. In that case, you might owe taxes on the conversion proportionate to the amount of pretax assets converted.

Step 6 – Report the conversion on your tax return:
To properly report the conversion to the IRS, you will need to fill out IRS Form 8606. This form will help you determine if any taxable income is due on the conversion. It is essential not to forget this step, as it ensures that you are compliant with the IRS rules and regulations.

Step 7 – Enjoy tax-free growth in your Roth IRA:
After successfully completing the Backdoor Roth IRA, you can enjoy the benefits of tax-free growth on your investments. Unlike a traditional IRA, qualified withdrawals from a Roth IRA are tax-free, making it an attractive option for retirement savings.

In conclusion, the Backdoor Roth IRA strategy provides a way for high-income individuals to contribute to a Roth IRA, taking advantage of the benefits it offers. Remember to check your eligibility, open a traditional IRA, make a nondeductible contribution, convert to a Roth IRA, pay any applicable taxes, report the conversion on your tax return, and reap the benefits of tax-free growth. Consult with a financial advisor or tax professional for personalized guidance as per your specific situation to maximize the advantages of this strategy.