We know that tax-deferred growth accounts such as a Roth IRA is one of the best investment vehicles we can use. But let’s say that you have the great problem of making more than $138,000/year (filing Single) – Well, you can’t contribute into one anymore! Thankfully, we can use something called a Backdoor Roth. Nic explains how high-income earners can still reap the benefits of tax-free dollars in retirement.

Host:
Nic Daniels BFA™, Financial Advisor

The Real Money Pros

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SPONSORS:

Academy Mortgage

Lively (HSAs and FSAs)

Tree City Advisors of Apollon

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Chapters:
00:00 – Intro
00:30 – Why contribute to IRAs?
01:28 – How a Backdoor Roth Conversion works
07:12 – Outro…(read more)

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Using a BACKDOOR ROTH for Tax-Deferred Growth

Many individuals are familiar with the concept of a Roth IRA, which allows you to contribute after-tax dollars and receive tax-free withdrawals in retirement. However, high-income earners are often unable to contribute directly to a Roth IRA due to income limitations. This is where the concept of a “backdoor Roth IRA” comes in – a strategy that allows high-income earners to take advantage of the tax benefits of a Roth IRA through a slightly different avenue.

Firstly, let’s understand how a backdoor Roth IRA works. The term “backdoor” comes from the process of making a non-deductible contribution to a Traditional IRA and then converting this Traditional IRA into a Roth IRA. By doing this, you essentially bypass the income limitations on Roth IRA contributions.

To utilize a backdoor Roth IRA strategy, follow these steps:

1. Check your eligibility: As mentioned earlier, high-income earners may be disqualified from contributing directly to a Roth IRA. However, there are no income limitations for making non-deductible contributions to a Traditional IRA.

2. Contribute to a Traditional IRA: Make a non-deductible contribution to a Traditional IRA. Keep in mind the annual contribution limits, which are $6,000 for individuals under 50 and $7,000 for those 50 and older.

3. Convert to a Roth IRA: Once your non-deductible contribution is made, promptly convert the funds into a Roth IRA. This conversion is tax-free, provided you do not have any pre-tax dollars in your Traditional IRA. Pay close attention to the timing to minimize any potential tax implications.

Now let’s explore the benefits of using a backdoor Roth IRA for tax-deferred growth:

1. Tax-free growth: Similar to a regular Roth IRA, the backdoor Roth IRA allows for tax-free growth on your investments. Over time, this can result in significant savings as your earnings compound without any tax implications.

2. Retirement flexibility: By contributing to a retirement account that offers tax-free withdrawals, you’ll have more control over your tax liability in retirement. This becomes increasingly valuable if tax rates rise or if you find yourself in a higher income bracket during retirement.

3. Estate planning advantages: Roth IRAs offer unique estate planning opportunities. Any funds in a Roth IRA will pass tax-free to your beneficiaries, allowing them to continue benefiting from tax-free growth. This can be a valuable asset to pass on to future generations.

4. Diversify tax strategies: Utilizing a backdoor Roth IRA can serve as a tool to diversify your tax strategies in retirement. If you have a combination of pre-tax retirement accounts (such as a 401(k) or Traditional IRA) and a Roth IRA, you’ll have the flexibility to withdraw from different accounts depending on your tax situation and optimize your tax liability.

In conclusion, a backdoor Roth IRA is a valuable strategy that high-income earners can use to benefit from tax-deferred growth. By making non-deductible contributions to a Traditional IRA and quickly converting it into a Roth IRA, you can enjoy the tax-free growth and flexibility that a Roth IRA offers. It is important to consult with a financial advisor or tax professional to ensure you navigate the process correctly and maximize the benefits of a backdoor Roth IRA for your specific financial situation.