Phased Out of a Roth IRA? Consider the Backdoor Method.
By Weston Manley
February 10, 2020
What is the backdoor Roth IRA who is it right for?
Let’s start with defining a Roth IRA (Roth). A Roth is a tax advantaged account where after tax dollars are contributed and any growth within the account is never taxed again. You can contribute up to $6,000 per person ($7,000 if you are over 50) in 2019 and 2020.
Those who have a modified adjusted gross income (adjusted gross income is a sufficient proxy) over $139,000 or $206,000, single and married filing jointly, respectively, are completely phased out from contributing directly to a Roth. This is where the backdoor version comes into play.
A backdoor Roth is a two-step process for high earners who are over the phaseout limitation to get funds into a Roth.
The first step is contributing to a traditional IRA and not taking the tax deduction (since you can’t as you are over the income limit), also called a nondeductible IRA or an IRA with cost basis.
Step two is converting (or transferring) the funds in the nondeductible IRA to a Roth.
The key to the strategy is having no pretax dollars in an IRA. Often, high earners have rollover IRA’s where prior company retirement plans (ie 401k or 403b) were transferred after leaving that employer. If this is the case for you then the backdoor Roth strategy is not likely to be advantageous as it would cause a tax liability.
Quick tax tip. If you self prepare taxes or use a tax preparation software like TurboTax be sure to fill out form 8606 so the federal government knows you owe no taxes on the conversion.
When you get to retirement, you’ll be happy to have Roth funds to supplement your pretax and taxable accounts as it’s a great way to manage your tax bracket throughout this part of your life.
WM
Weston is a Certified Public Accountant, Certified Financial Planner TM, and holds the Chartered Financial Analyst designation. In addition, Weston earned his master’s degree in accountancy from the University of Missouri – Columbia. Weston is active in the St. Louis community and board member of the Anti-Defamation League.