In this video, I will teach you how to make a backdoor Roth IRA contribution. This strategy allows higher-income earners to still add funds to a Roth IRA account….(read more)

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If you’re a high-income earner and thought you were ineligible to contribute to a Roth IRA, think again. With a little-known strategy known as a backdoor Roth IRA contribution, you can still take advantage of the benefits of a Roth IRA, regardless of your income level.

A Roth IRA offers tax-free growth and tax-free withdrawals during retirement, making it an attractive retirement savings option for many individuals. However, there are income limits that restrict high earners from directly contributing to a Roth IRA. For 2021, the income limit for single filers is $140,000 and for married filers, it’s $208,000.

But with a backdoor Roth IRA contribution, there are no income limits to contend with, allowing high earners to bypass the income restrictions and contribute to a Roth IRA. Here’s how you can make a backdoor Roth IRA contribution:

Step 1: Make a non-deductible traditional IRA contribution
Since there are no income limits for making traditional IRA contributions, you can make a non-deductible contribution to a traditional IRA regardless of your income level. For 2021, the contribution limit for traditional IRAs is $6,000 ($7,000 if you’re age 50 or older).

Step 2: Convert your traditional IRA to a Roth IRA
Once you’ve made your non-deductible traditional IRA contribution, the next step is to convert your traditional IRA to a Roth IRA. This can be done by transferring the funds from your traditional IRA to a Roth IRA. There are no income limits for Roth IRA conversions, so high earners can take advantage of this strategy to fund a Roth IRA.

Keep in mind that if you have other pre-tax IRA balances, such as deductible contributions or earnings in a traditional IRA, the tax implications of the conversion can be more complex. It’s essential to consult with a tax professional to understand the potential tax consequences of a Roth IRA conversion.

Step 3: Pay attention to the pro-rata rule
When performing a Roth IRA conversion, it’s crucial to be aware of the pro-rata rule, which can impact the tax treatment of the conversion. The pro-rata rule takes into account all of your pre-tax and after-tax IRA balances when determining the tax consequences of a Roth IRA conversion.

If you have pre-tax IRA balances, such as deductible contributions or earnings, the pro-rata rule may result in a portion of your conversion being subject to income tax. To minimize the tax impact, consider rolling over any pre-tax IRA balances into a qualified retirement plan, such as a 401(k), before performing a backdoor Roth IRA conversion.

By utilizing a backdoor Roth IRA contribution, high-income earners can take advantage of the benefits of a Roth IRA, including tax-free growth and tax-free withdrawals, without being constrained by income limits. While the strategy may require careful planning and consideration of tax implications, it can be a powerful tool for building tax-efficient retirement savings. As always, it’s important to seek guidance from a financial advisor or tax professional to determine the best approach for your individual circumstances.