November 3, 2021

The Backdoor Roth IRA Conversion

The “Loophole”

Roth IRA accounts have been discussed in a previous blog cleverly titled, Roth IRA Basics. One of the rules to establish a Roth IRA was an income under the income limits of $120,000 for a single tax filer and $190,000 for a married couple filing jointly. Did you know you have options if you make more than the limit?

In 2010, tax laws were changed to remove the income limits on conversions of Traditional IRAs to Roth IRAs, the Backdoor Roth IRA was born. As long as certain rules are followed, an extra administrative step allows individuals or married couples to contribute funds to a Roth IRA.

First, remove pitfalls: this can be complex, please give me a call.

  • Move all traditional, SEP and SIMPLE IRAs into a 401k or convert to Roth to avoid the IRA aggregation rule.
  • Make sure to retain the proof of cost basis so you don’t get double taxed. Let your accountant know so they can track the non-deduction.
  • Recently the IRS removed the ability to de-convert after the fact. Now, once it’s done, it’s irreversible.

How it works:

The first step in the Backdoor Roth IRA conversion: The investor contributes to a Traditional IRA with after tax dollars, meaning they do not take a deduction. Then the monies are transferred from the Traditional IRA to the Roth IRA via a Roth Conversion. Since there is no deduction, there is no taxes resulting from the conversion. This finishes the steps to make a Backdoor Roth IRA contribution. All IRA rules must be followed throughout the process: not to exceed the contribution limits per year, IRAs cannot be touched before age 59.5 without a penalty for early withdrawal (expect in certain instances), contributions for the year must be made by 4/15 of the following year.

Always consult your financial advisor and CPA before making any of these contributions. You must adhere to multiple rules to make sure that your contribution is legal and does not come with any tax consequences. If you have any questions about this topic or any other, please contact your Engage team to set up a meeting.

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