Learn about and understand the process of a Backdoor Roth IRA Conversion/Contribution….(read more)

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A Backdoor Roth IRA is a strategy used by individuals who have a high income and are not eligible to make direct Roth IRA contributions. To implement a Backdoor Roth IRA, the individual must first make a non-deductible contribution to a Traditional IRA and then convert it to a Roth IRA. This strategy allows individuals with high incomes to take advantage of the tax benefits of a Roth IRA.

The Backdoor Roth IRA has gained popularity in recent years due to the increasing number of people who exceed the income limits for direct Roth IRA contributions. In 2021, the income limit for a single taxpayer to make a full Roth IRA contribution is $140,000, and for married couples filing jointly, it is $208,000. The Backdoor Roth IRA strategy offers a way for high-income earners to contribute to a Roth IRA, despite not meeting these eligibility requirements.

The first step towards implementing a Backdoor Roth IRA is to open a Traditional IRA account. Once the account is open, the individual can make a non-deductible contribution up to $6,000 (or $7,000 if they are age 50 or older) for the 2021 tax year. The non-deductible contribution means that the individual does not receive a tax deduction for the contribution, but the money will grow tax-free in the Traditional IRA until it is converted to a Roth IRA.

The next step is to convert the Traditional IRA to a Roth IRA. This conversion can be done at any time, but it is recommended to wait a few days or weeks after making the non-deductible contribution to avoid paying taxes on any gains in the account. When converting the Traditional IRA to a Roth IRA, the individual will owe taxes on any gains in the account but not on the original contribution, since it was made with after-tax dollars.

It is important to note that individuals who have other Traditional IRA accounts may need to consider the pro-rata rule when implementing a Backdoor Roth IRA. The pro-rata rule states that if an individual has both pre-tax and after-tax money in Traditional IRA accounts, the tax owed on a Roth IRA conversion is based on the ratio of pre-tax to after-tax money in all of their Traditional IRA accounts.

In conclusion, a Backdoor Roth IRA is a strategy used by individuals with high incomes to contribute to a Roth IRA despite not meeting the eligibility requirements. The strategy involves making a non-deductible contribution to a Traditional IRA and then converting it to a Roth IRA. Despite being a relatively simple strategy, it is important to understand the pro-rata rule and consult with a tax professional before implementing a Backdoor Roth IRA. By utilizing this strategy, high-income earners can take advantage of the tax benefits of a Roth IRA and potentially save on future taxes.