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For many investors, a Roth IRA is an ideal investment vehicle to save for retirement. However, for those who earn too much to qualify for a traditional Roth IRA, a backdoor Roth IRA might be an attractive option. Backdoor Roth IRA contributions have gained popularity over the years since its establishment by Congress with the passage of the Tax Increase Prevention and Reconciliation Act of 2005. Let’s delve into what a backdoor Roth IRA is and its benefits, and how you can use it to save for your retirement.

First, a bit of background. Roth IRA contributions are made with after-tax dollars. Earnings and withdrawals are typically tax-free, provided certain requirements are met, such as being at least 59 1/2 years old and the account being open for at least five years. In 2021, individuals with modified adjusted gross incomes of up to $140,000 (single filers) or $208,000 (married filing jointly) can make annual Roth IRA contributions of up to $6,000 if they are under age 50, and $7,000 if they are 50 years of age or older.

A backdoor Roth IRA is a strategy that allows high earners, who would typically not qualify for a Roth IRA due to income limitations, to contribute to a Roth IRA by making an after-tax contribution and then immediately converting to a Roth IRA. There are no income limits for conversions, rendering it an effective option for those who are ineligible for a traditional Roth IRA. As a result, high earners are still eligible to enjoy tax-free growth and tax-free distributions.

For starters, you contribute to a traditional IRA, which doesn’t have any income limits for contributions. After contributing, you then convert the traditional IRA to a Roth IRA, which triggers a tax bill. You will owe taxes only on earnings that took place between the time you made the contribution and when you completed the conversion. Because you are funding your account with after-tax money, the tax implications of such conversions will, in most cases, be minimal.

You must be careful, however, not to run afoul of the pro-rata rule, which applies if you already have a traditional IRA. The pro-rata rule forces you to consider all of your traditional IRA assets, including the nondeductible contributions made when you funded your backdoor Roth IRA, when calculating the taxable portion of any IRA distributions you take.

Overall, backdoor Roth IRA conversion is a move to consider if you’re a high earner who wants to take advantage of Roth IRA benefits, even though you’re not eligible to contribute directly. You can use this technique, especially if you have no existing IRAs, while being careful to minimize tax consequences. It’s also worth consulting with a financial advisor or tax expert, given the complexities surrounding this investment vehicle.