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Details and tax implications to keep in mind from tax and IRA expert Ed Slott.

00:00 Introduction

00:21 Backdoor Roth IRAs

05:24 Tax Impact of Backdoor Roth IRA Contributions

08:09 Backdoor Roth IRA Strategies

09:48 Mega Backdoor Roth IRA

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A Backdoor Roth IRA is a way for high-income earners to contribute to a Roth IRA, even if they are not eligible to do so due to income limits. This strategy involves making non-deductible contributions to a Traditional IRA and then converting those funds to a Roth IRA. Here’s how you can effectively use a Backdoor Roth IRA:

1. Understand the income limits: In order to use a Backdoor Roth IRA, you must first determine if you exceed the income limits for directly contributing to a Roth IRA. For 2021, the income limits are $140,000 for single filers and $208,000 for married couples filing jointly.

2. Contribute to a Traditional IRA: If you are above the income limits for a Roth IRA, you can make a non-deductible contribution to a Traditional IRA. For 2021, the contribution limit is $6,000 for individuals under 50, and $7,000 for those 50 and older.

3. Convert to a Roth IRA: After making your non-deductible contribution to a Traditional IRA, you can then convert those funds to a Roth IRA. This conversion can be done through a trustee-to-trustee transfer or by directly requesting the transfer from your financial institution.

4. Pay taxes on any gains: One thing to keep in mind is that if your Traditional IRA has any earnings between the time you made the contribution and the time you convert it to a Roth IRA, you will need to pay taxes on those gains. This is due to the pro-rata rule, which determines how much of the conversion is subject to taxation based on the ratio of your pre-tax and post-tax dollars in all of your Traditional IRAs.

5. Consider the timing: It’s important to consider the timing of the conversion, as any gains in your Traditional IRA will be subject to taxation. Some individuals choose to convert their Traditional IRA to a Roth IRA soon after making the non-deductible contribution in order to minimize the tax implications.

6. Monitor your accounts: Once you have completed the conversion to a Roth IRA, make sure to monitor your accounts regularly and keep track of any tax implications. Consult with a financial advisor or tax professional if you have any questions or concerns.

In conclusion, using a Backdoor Roth IRA can be a smart strategy for high-income earners looking to take advantage of the benefits of a Roth IRA. By understanding the income limits, making non-deductible contributions to a Traditional IRA, and converting those funds to a Roth IRA, you can effectively grow your retirement savings. As always, it’s important to educate yourself on the rules and regulations surrounding Backdoor Roth IRAs and seek professional advice if needed.