Those of you that may have income that exceeds the phaseout thresholds for contributing directly to a Roth IRA, may benefit from the infamous “backdoor” Roth IRA strategy – which is really just an indirect way of getting contributions into a Roth IRA.

In order to execute this strategy, it’s extremely important to have a clear understanding of these 3 things:

1. IRA contribution limits;
2. the process for executing a “backdoor” Roth IRA conversion;
3. and most importantly, the pro-rata rule….(read more)

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The Roth IRA is a game-changer when it comes to retirement savings. Unlike traditional IRA contributions, Roth IRA contributions are made with after-tax dollars, which means that withdrawals in retirement are tax-free. But what if you make too much money to contribute directly to a Roth IRA?

Enter the backdoor Roth IRA conversion strategy. This tax planning technique involves making non-deductible contributions to a traditional IRA and then converting the funds to a Roth IRA.

Here’s how it works:

1. Contribute to a Traditional IRA – First, you’ll need to contribute to a traditional IRA. However, since your income exceeds the limit for deductible contributions, you’ll need to make a non-deductible contribution. This is known as a “non-deductible contribution” because you won’t get a tax deduction for it.

2. Wait – Next, you’ll need to wait a bit. Specifically, you should wait until the contribution has cleared and the money is in your traditional IRA account.

3. Convert to a Roth IRA – Once the money is in your traditional IRA account, you can then convert it to a Roth IRA. This is where the magic happens. Since you paid taxes on the original contribution, you won’t owe any additional taxes on the conversion.

4. Repeat – You can repeat this process each year to continue building tax-free retirement savings.

There are a couple of things to keep in mind when using this strategy. First, the IRS considers all your traditional IRA accounts together as one when it comes to taxation. This means that if you have pre-tax dollars in any traditional IRA, those funds will be subject to taxation if you do a backdoor Roth IRA conversion.

Second, you can’t convert a portion of your traditional IRA to a Roth IRA. You must convert the entire account balance, including any pre-tax funds. This can create a tax liability, so it’s important to plan accordingly.

Overall, the backdoor Roth IRA conversion strategy is a powerful tool for high earners who want to take advantage of the tax benefits of a Roth IRA. By making non-deductible contributions to a traditional IRA and converting them to a Roth IRA, you can build a tax-free retirement nest egg. However, it’s important to consult with a financial planner or tax professional to ensure that this strategy is right for you.