Do you make too much money to contribute to a traditional Roth IRA?

Check out this clip to learn what a backdoor Roth IRA is and how high-income earners can still get tax advantages down the road through this workaround.

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When it comes to retirement savings, a Roth IRA is often considered one of the best options available. This type of account allows you to save after-tax dollars, meaning that you won’t have to worry about being taxed when it comes time to withdraw your savings in retirement. However, not everyone is eligible to open a Roth IRA due to income limitations. That’s where a Backdoor Roth IRA comes in.

A Backdoor Roth IRA is essentially a way for individuals who exceed the income limits for a traditional Roth IRA to still take advantage of the benefits of a Roth IRA. Here’s how it works:

Step 1: Open a Traditional IRA

The first step to setting up a Backdoor Roth IRA is to open a traditional IRA. These accounts don’t have any income limits, so anyone can open one. However, if you already have a traditional IRA with pre-tax funds, you’ll need to consider the pro-rata rule when converting to a Roth IRA. This rule makes the conversion process a bit more complex and may result in some tax liability.

Step 2: Make a Non-Deductible Contribution

Once you have a traditional IRA account, you’ll need to make a non-deductible contribution. This is an after-tax contribution that won’t be subject to income taxes when it comes time to make a conversion to a Roth IRA. For the 2021 tax year, the maximum non-deductible contribution for an IRA is $6,000, or $7,000 if you’re 50 or older.

Step 3: Convert the Traditional IRA to a Roth IRA

The final step in setting up a Backdoor Roth IRA is to convert your traditional IRA to a Roth IRA. This involves transferring the funds from your traditional IRA to your Roth IRA account. Since you’ve already paid taxes on the non-deductible contribution (step 2), you won’t owe any additional taxes on the conversion to the Roth IRA.

It’s important to note that the IRS does have rules around the timing of these steps. Specifically, you’ll want to make sure that you complete the conversion process before the end of the year to avoid any tax issues. Plus, you’ll need to be mindful of any other traditional IRA accounts you may have, as mentioned previously.

In conclusion, a Backdoor Roth IRA can be an excellent option for high earners who want to take advantage of the benefits of a Roth IRA. While the process may seem complicated, it can be well worth the effort in the long run. As always, it’s important to consult with a financial advisor or tax professional before making any decisions about your retirement savings.