In recent weeks, we’ve talked a lot about the Roth IRA, and more specifically, the Backdoor Roth; here’s how it works and exactly how to do it.
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IRA Financial was founded by Adam Bergman, a former tax and ERISA attorney who worked at some of the largest law firms. During his years of practice, he noticed that many of his clients were not even aware that they can use an IRA or 401(k) plan to make alternative asset investments, such as real estate. He created IRA Financial to help educate retirement account holders about the benefits of self-directed retirement plan solutions.

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Saving for retirement is crucial for everyone, but when faced with limited options, it can be challenging. For high-income earners, the options for contributing to a Roth IRA can be severely restricted. However, the backdoor Roth IRA loophole allows for high-income earners to contribute to a Roth IRA.

A Roth IRA offers tax-free withdrawals in retirement, making it an attractive option for those looking to maximize their retirement savings. For 2021, individuals can contribute up to $6,000 to their Roth IRA, and those over 50 can contribute an additional $1,000 as a catch-up contribution.

However, high-income earners, those with modified adjusted gross incomes (MAGI) over $140,000 for individuals or $208,000 for married couples filing jointly, are not allowed to contribute directly to a Roth IRA. This limitation is where the Backdoor Roth IRA comes in.

What is a Backdoor Roth IRA?

A Backdoor Roth IRA is a way for high-income earners to contribute to a Roth IRA by following certain steps. It involves two transactions: a non-deductible individual retirement account (IRA) contribution and a conversion to a Roth IRA.

As high-income earners are not allowed to contribute directly to a Roth IRA, they can first contribute to a traditional IRA. Individuals can then convert these traditional IRA contributions to Roth IRA assets, allowing them to take advantage of the tax-free withdrawals and growth that a Roth IRA offers.

How to do a Backdoor Roth IRA

To do a Backdoor Roth IRA, follow these steps:

1. Make a non-deductible contribution to a traditional IRA.

As high-income earners are not allowed to deduct contributions to a traditional IRA, a non-deductible contribution is the best option. The maximum non-deductible contribution for 2021 is $6,000. Couples filing jointly can contribute $12,000 in total.

2. Convert your traditional IRA contribution to a Roth IRA.

After making the non-deductible contribution to your traditional IRA, you will need to convert your traditional IRA contribution to a Roth IRA. The conversion process will require you to pay taxes on any pre-tax contributions or earnings that have accrued in the traditional IRA funds.

If you have other traditional IRA funds, you will need to be careful not to trigger the pro-rata rule. The pro-rata rule states that when determining the taxable portion of your Roth conversion, the IRS will consider all of your traditional IRA funds. This means that if you have other pre-tax contributions in traditional IRAs, you will have to pay taxes on the combined amount.

3. Report your conversion.

You will need to report your conversion on your tax return. You will also need to file Form 8606 with your tax return to indicate the non-deductible nature of the contribution.

Conclusion

The Backdoor Roth IRA offers high-income earners an opportunity to contribute to a Roth IRA and reap the benefits of tax-free withdrawals and growth. It is essential to note that the conversion process is not for everyone and may not be the best option for all individuals. It is best to consult a financial advisor or tax professional to determine the best course of action for your retirement savings.