If you want to fund a Roth IRA, but have been told you make too much money, this might help you still get your annual contribution into a Roth IRA. There are a couple things to watch out for if you have existing Traditional IRA money on the balance sheet.

0:43 Concept of Back Door Roth IRA
1:35 Do you make too much to directly fund a Roth IRA?
4:10 Logistical Summary
5:15 Example
6:53 Pro Rata Rules(aka if you have existing pre-tax IRA money on the balance sheet)
9:22 Pro Rata Workaround

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A backdoor Roth IRA is a great way for high-income earners to contribute money to a Roth IRA, even if they are not eligible for this type of retirement account. A Roth IRA is an investment account that allows you to deposit after-tax money, which then grows tax-free, and any qualified withdrawals are also tax-free.

However, there is an income limit for contributing to a Roth IRA. In 2021, this income limit is $140,000 for single filers and $208,000 for married couples filing jointly. If you exceed this income limit, you are not eligible to contribute directly to a Roth IRA.

This is where the backdoor Roth IRA comes in. This approach involves opening a traditional IRA account and making a non-deductible contribution (meaning you do not get a tax deduction for the contribution). Then, you convert the traditional IRA account into a Roth IRA account. The contribution to the traditional IRA is not deductible, so it does not reduce your taxable income for that year. However, the conversion to the Roth IRA is a taxable event. This means you will have to pay taxes on any gains in the traditional IRA account when you convert it to a Roth IRA.

One thing to keep in mind is the pro-rata rule, which can impact your backdoor Roth IRA strategy. This rule states that if you have other traditional IRA accounts with pre-tax money, the conversion to a Roth IRA will be subject to taxes based on the percentage of pre-tax dollars in all of your traditional IRA accounts. Therefore, it’s best to avoid having any other traditional IRA accounts if you plan to use the backdoor Roth IRA strategy.

Another consideration is timing. Ideally, you want to convert the traditional IRA account to a Roth IRA as soon as possible after making the non-deductible contribution. This will minimize the amount of gains in the account and reduce taxes.

In conclusion, a backdoor Roth IRA is a great option for high-income earners who want to take advantage of the tax-free growth and withdrawals offered by a Roth IRA. However, it is important to consider the pro-rata rule and timing when implementing this strategy. Consulting with a financial advisor can help ensure you are making the best decisions for your retirement planning.