Backdoor ROTH IRA explained for beginners. This is a technique that high-income earners can use to work around the ROTH IRA income limits. The move involves one CONTRIBUTING post-taxed money to a Traditional IRA, and then later CONVERTING them into a ROTH IRA. This conversion is tax-free for the most part (see exceptions in the video).

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If you’re just getting started with retirement planning, the world of Individual Retirement Accounts (IRAs) can be a bit overwhelming. There are two main types of IRAs – Traditional and Roth – each with its own set of advantages and disadvantages.

However, there is also something called a Backdoor Roth IRA, which is a strategy that can help you maximize your retirement savings. In this article, we’ll explain what a Backdoor Roth IRA is and how it works, complete with helpful animations to guide you through the process.

First, let’s start with a quick overview of traditional and Roth IRAs. With a traditional IRA, you contribute money pre-tax, meaning you don’t pay taxes on the money you put in each year. The downside is that when you withdraw that money during retirement, you’ll pay taxes on it.

With a Roth IRA, you contribute money post-tax, meaning you pay taxes on the money you put in each year. However, when you withdraw that money during retirement, you won’t pay any taxes on it. This can be a huge advantage if you expect to be in a higher tax bracket during retirement than you are now.

So, what is a Backdoor Roth IRA? It’s a way for high-income earners to still take advantage of a Roth IRA, despite some income limitations. This is because there are income limits for contributing to a Roth IRA – in 2021, if you’re single, you can’t contribute at all if your income is over $140,000. If you’re married filing jointly, you can’t contribute if your income is over $208,000.

But with a Backdoor Roth IRA, you contribute money to a traditional IRA (without taking a tax deduction), and then you convert that money to a Roth IRA. This allows you to get around the income limitations of a traditional Roth IRA.

Here’s how it works in five simple steps:

Step 1: Contribute to a Traditional IRA – You can contribute up to $6,000 per year (or $7,000 if you’re age 50 or older) to a traditional IRA. When you contribute to a traditional IRA, you won’t get a tax deduction for your contribution.

Step 2: Wait a bit – it is recommended to wait a few days before doing the next step in order to avoid any confusion.

Step 3: Convert to a Roth IRA – You can then convert the money from your traditional IRA to a Roth IRA. This is where the “Backdoor” part comes in.

Step 4: Pay taxes (if necessary) – If you’ve already paid taxes on the money in your traditional IRA, you don’t need to pay taxes again. But if you haven’t paid taxes yet (because, for example, you contributed money to a traditional IRA but didn’t take a deduction), you’ll need to pay taxes on that money when you convert it to a Roth IRA.

Step 5: Enjoy tax-free growth – Once your money is in a Roth IRA, it will grow tax-free. This means that when you withdraw the money during retirement, you won’t owe any taxes on it.

And that’s it! As you can see, it’s a relatively simple process that can have significant benefits over time. Plus, by using a Backdoor Roth IRA, you’ll have more control over your retirement savings and won’t have to worry about reaching income limits.

Of course, it’s always best to consult with a financial advisor before making any big decisions about your retirement savings. But hopefully, this article has helped explain what a Backdoor Roth IRA is and how it can benefit you. Happy saving!