Roth IRA Back Door Strategy
This video covers the income limits of a Roth IRA and how it is possible to still invest using a Roth IRA even if you exceed the income limits.

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The Roth IRA backdoor strategy is a method for high-income earners to take advantage of the benefits of a Roth Individual retirement account (IRA), even if they exceed the income limits set by the Internal Revenue Service (IRS). By utilizing this strategy, individuals can enjoy tax-free growth and tax-free withdrawals during their retirement years.

Before we dive into the strategy, let’s first understand what a Roth IRA is. A Roth IRA is a retirement investment account that allows individuals to contribute after-tax dollars. The contributions made to a Roth IRA are not tax-deductible, meaning you don’t receive an immediate tax benefit as you do with a traditional IRA. However, the real advantage of a Roth IRA lies in the tax-free growth and tax-free withdrawals it offers.

Now, let’s discuss the income limits that the IRS imposes on Roth IRA contributions. For unmarried individuals, the income limit to fully contribute to a Roth IRA in 2021 is $140,000. For married couples filing jointly, the limit is $208,000. If your income exceeds these limits, you are typically ineligible to contribute to a Roth IRA directly.

This is where the backdoor strategy comes into play. The backdoor strategy involves making a non-deductible contribution to a traditional IRA and then converting that contribution into a Roth IRA. Since there are no income limits on contributing to a traditional IRA, this method allows high-income earners to indirectly contribute to a Roth IRA.

Here’s how the Roth IRA backdoor strategy works. First, you make a non-deductible contribution to a traditional IRA. The contribution amount can vary each year, but in 2021, the maximum contribution is $6,000 for individuals under the age of 50 and $7,000 for individuals aged 50 and above.

Once the non-deductible contribution is made, you then convert the traditional IRA into a Roth IRA. The conversion amount is considered a taxable event, but since you made a non-deductible contribution, only the earnings on the contribution are subject to income tax. If you converted the traditional IRA into a Roth IRA shortly after making the contribution, the earnings may be minimal, resulting in little to no tax liability.

It’s important to note that if you already have a pre-tax traditional IRA, the backdoor strategy can become more complex due to the pro-rata rule. The pro-rata rule requires you to consider all of your traditional IRA balances when converting to a Roth IRA, potentially triggering additional taxes.

To avoid this issue, individuals may consider rolling over their pre-tax traditional IRA into their employer-sponsored retirement plan, such as a 401(k), if allowed by their plan. By doing so, you can eliminate the pre-tax traditional IRA balance and simplify the backdoor strategy.

While the Roth IRA backdoor strategy can be an effective way to take advantage of the benefits of a Roth IRA, it’s always advisable to consult with a tax professional or financial advisor before implementing any tax or investment strategy. They can help you navigate the rules and regulations surrounding the strategy, ensuring you’re making the most informed decisions for your financial future.

In conclusion, the Roth IRA backdoor strategy provides a way for high-income earners to contribute to a Roth IRA despite exceeding income limits. By making non-deductible contributions to a traditional IRA and then converting it to a Roth IRA, individuals can enjoy tax-free growth and tax-free withdrawals in their retirement years. However, it’s important to understand the rules and potential tax implications before utilizing this strategy.