"Roth IRAs." An individual retirement account (IRA) is an investing tool individuals use to earn and earmark funds for retirement savings. You pay no tax on either principal or earnings when you withdraw your money (although you must be at least age 59½ and have had the Roth for five years). A backdoor Roth IRA is not a tax dodge—in fact, it might incur higher taxes when it's established—but it does provide investors with future tax savings. Many high-income earners believe that they can’t contribute to a Roth IRA because they make too much money and/or because they participate in a company 401(k) plan. Why Do a Backdoor Roth IRA? Retirement. Since the income limits on Roth conversions were removed in 2010, higher-income individuals who are not eligible to make a Roth IRA contribution have been able to make an indirect “backdoor Roth contribution” instead, by simply contributing to a non-deductible IRA (which can always be done regardless of income) and converting it shortly thereafter. However, not everyone can use a Roth IRA. Every investor is eligible to do one Roth IRA conversion a year. That can be a difficult decision. With target date funds, you start by investing in high-risk, high-reward options and then switch to low-risk, low-reward options as you get closer to retirement. If you are considering a mega-backdoor Roth, you first should be maxing out your 401(k) and IRA contributions. A backdoor Roth IRA is a convenient loophole that allows high-income individuals to enjoy all the tax benefits that a Roth IRA has to offer by converting a traditional IRA into a Roth IRA. Such IRA conversions could be reversed in a process called a recharacterization. “If you expect to owe a little less in taxes for the year, and you can handle the tax bill for a Roth conversion now, it might make sense,” said Russell. Finally, What is a Backdoor Roth IRA Conversion? It allows you to circumvent the Roth income restrictions and contribute to the retirement vehicle even if you’re earning more than $135,000 a year. Once you've converted from traditional to Roth assets, you'd be able to enjoy the tax-free withdrawal status of that account. 6 Minute Read First, let’s look at a few of the key advantages to doing a backdoor Roth IRA: Sounds great, right? This characteristic is most beneficial if you think tax rates are going to rise in the future, or that your taxable income will be higher after you retire than it is now. There’s no time requirement on when you have to withdraw money, if ever—an appealing option for those wanting to leave th… All rights reserved. We also reference original research from other reputable publishers where appropriate. That’s it! But that’s not the case at all—you’re just deciding to pay your taxes on your retirement savings now instead of later. A backdoor Roth IRA is a legal way to get around the income limits that normally restrict high-earners from contributing to Roths. With recent regulation and tax changes, it might be the right time for a Roth conversion. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Find an investing pro in your area today. You see, there are income limits set up by the IRS designed to keep high-income earners from opening up and contributing to a Roth IRA based on how much they make a year. Essentially, this helps you to get around Roth IRA income limits. Use a Roth IRA to Avoid Paying Estate Taxes, Mistakes People Make With Roths and Their Estates, Rules for RMDs for Inherited IRA Beneficiaries, Brokerages that offer both traditional IRAs, Publication 590-A (2019), Contributions to Individual Retirement Arrangements (IRAs), Income Ranges for Determining IRA Eligibility Change for 2021. These include white papers, government data, original reporting, and interviews with industry experts. But I’ve got to warn you up front that there are a couple of downsides and limitations to doing a backdoor Roth IRA: You might feel intimidated by the idea of doing a backdoor Roth IRA, but the truth is it’s really not that hard to set up. But how do you know it’s the right move for you? Backdoor Roth IRAs are not a special type of account; rather, they are usually traditional IRA accounts or 401(k)s which have been converted to Roth IRAs. Brokerages that offer both traditional IRAs and Roth IRAs provide assistance with the strategy, which basically involves converting a traditional IRA into the Roth variety. You can use an existing traditional IRA, or open a new account specifically for the conversion. We’ll show you how to do it! I can’t stress this enough: You should only do a backdoor Roth IRA if you have the cash on hand to pay the taxes you owe without taking money out of the traditional IRA itself. A Backdoor Roth IRA is not the same as a Roth 401(k) contribution. Which brings us to . With a Roth IRA, you get no up-front tax deduction, as you do with a traditional IRA, 401(k) retirement plan or other tax-deferred account. Accessed Nov. 16, 2020. The Backdoor Roth can be thought of as a backup plan for how to contribute to a Roth IRA. While there are limits to how much you can invest in an IRA each year, there are no restrictions on how much you can convert to a Roth IRA. What Are Target Date Funds? You can do a backdoor Roth IRA in one of several ways. A mega backdoor Roth lets people save as much as $37,500 in a Roth IRA or Roth 401(k) in 2020. Unfortunately, the IRS says that high-income earners are not allowed to open up or contribute to a Roth IRA . . Backdoor Roth Tutorial Steps. We’ll walk you through it. The main advantage of a backdoor Roth IRA—as with Roths in general—is that you pay taxes upfront on your contributions, and everything after that is tax-free. If you don’t have a traditional IRA, you can connect with an investment professional who can help you set up an account and pick the right mutual funds to put into your traditional IRA. Now, traditional IRAs are usually funded with pre-tax money, which means you aren’t paying taxes on that money yet. A backdoor Roth IRA is a convenient loophole that allows high-income individuals to enjoy all the tax benefits that a Roth IRA has to offer by converting a traditional IRA into a … It’s that simple and it’s perfectly legal. For all you high-income earners out there, there is a way to get your money into a Roth account. If your traditional IRA account has at least $6,000, you can freely roll over more money than the yearly contribution. Be confident about your retirement. In 2020, if you’re single and make more than $139,000 or married and earn more than $206,000, then Uncle Sam says you cannot open or contribute to a Roth IRA.1. Then, move the money into a Roth IRA using a Roth conversion. So if you put $6,000 into a traditional IRA and want to convert that into a Roth IRA, you’ll have to pay taxes on that $6,000. This is different than a traditional 401K, which provides a reduction in your adjusted gross income. . A traditional IRA (individual retirement account) allows individuals to direct pre-tax income toward investments that can grow tax-deferred. which means anyone can open up a traditional IRA and put money into it. Before you decide if a backdoor Roth IRA contribution is the right move, carefully consider your reasons for making the conversion. It’s the best of both worlds! How to do a Backdoor Roth IRA Accessed July 29, 2020. You can learn more about the standards we follow in producing accurate, unbiased content in our. A third way to make a backdoor Roth contribution is by making an after-tax contribution to a 401(k) plan and then roll it over to a Roth IRA.. For those who earn above the Roth income limit to contribute directly into a Roth IRA, the process works like this. Another way is to convert your entire traditional IRA account to a Roth IRA account. Your IRA custodial bank or brokerage should be able to help you with the mechanics. 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