Colin Day, CFP, EA, MBA is taking us on a journey through financial planning.

In today’s video we’re discussing the back door Roth strategy. For some, your income might exceed the limit to allow you to contribute to a Roth IRA. While some might give up on their ability to contribute to a Roth IRA, others might try the back door Roth conversion, which allows you to get money into the Roth while exceeding the annual income limit.

To do so, you contribute money to a Traditional IRA on a non-deductible basis and then move those dollars into the Roth IRA through a process known as a “conversion.”

While this can be a great strategy to get money into a Roth, there are many reasons why you’ll want to pause before considering using it.

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Daily Video Series – Day 7, “The Backdoor Roth”

Welcome to the seventh day of our Daily Video Series! Today, we are diving into a hot topic among tax-savvy investors – “The Backdoor Roth.” In this video, we will explore the ins and outs of this strategy, highlighting its benefits, limitations, and how you can utilize it to enhance your retirement savings.

The traditional Roth IRA allows individuals to contribute after-tax dollars, and the earnings on these contributions grow tax-free. However, there are income limits in place that prevent high-earning individuals from directly contributing to a Roth IRA. This is where the “backdoor” comes in.

The Backdoor Roth strategy allows individuals to circumvent the income limits that prevent them from making direct contributions to a Roth IRA. By following a specific process, individuals can contribute to a Traditional IRA and then convert it into a Roth IRA, allowing for the same benefits of tax-free growth.

So, how does it work? Let’s break it down step by step:

1. First, ensure you are eligible for a backdoor Roth. The income limits for contributing directly to a Roth IRA are $140,000 for individuals and $208,000 for married couples filing jointly (2021 limits). If your income exceeds these limits, the backdoor Roth strategy might be right for you.

2. Open a Traditional IRA: If you don’t already have one, open a Traditional IRA. There are no income limits to contribute to a Traditional IRA.

3. Contribute to your Traditional IRA: Make a non-deductible contribution to your Traditional IRA. It’s important to note that you cannot deduct these contributions on your tax return.

4. Conversion time: Once the funds are in your Traditional IRA, you’ll need to convert them into a Roth IRA. This can be done either through a direct conversion within the same financial institution or by transferring the funds to a different institution.

5. Taxes: When performing the conversion, keep in mind that you might owe taxes on any pre-tax earnings in your Traditional IRA. This is known as the “pro-rata rule” and can complicate matters if you have existing pre-tax contributions in other Traditional IRAs.

The backdoor Roth strategy can be a game-changer for high-income earners who want to take advantage of the tax-free growth and withdrawals in retirement. By contributing to a Traditional IRA and subsequently converting it to a Roth IRA, individuals can bypass the income limits set for direct Roth IRA contributions.

However, there are a few caveats to consider. The pro-rata rule can make the strategy less appealing if you have pre-tax contributions in other Traditional IRA accounts, as it may lead to significant tax consequences. Additionally, it’s crucial to consult with a financial advisor or tax professional to ensure that the backdoor Roth strategy aligns with your overall financial plan.

In conclusion, the backdoor Roth strategy offers an opportunity for high-income earners to maximize their retirement savings and benefit from tax-free growth. While it requires careful planning and consideration, it can be a valuable tool in building a tax-efficient retirement portfolio. Stay tuned for our next Daily Video Series installment, where we will explore more financial strategies to help you make the most of your money.