"My income is too high to contribute to a Roth IRA so I don't have one."
I cannot tell you how many times this has been told to me by high income earners.
If this is something you believe, you are not alone. There are income restrictions to directly contribute to a Roth IRA.
But here's a secret for you, that top line is a myth. Anyone can get money into a Roth IRA, it just takes a couple extra steps for high income earners.
Let me introduce you to the backdoor Roth IRA.
Backdoor ROTH's are one of the most utilized strategies out there for high income earners to get more tax free dollars for the future. In this post I will walk you through:
If you make under $146k (based on MAGI) in 2024, you can contribute to a regular ROTH IRA. However, if you make more than that, you cannot Anyone making over $146k a year (single) or $230k (married), will want to become familiar with the backdoor Roth.
In 2024, you are able to do $7,000 (If over 50 by December 31, you can contribute an extra $1,000) to a ROTH IRA or backdoor Roth IRA. This is up from $6,500 in 2023. It’s not a super high amount, but it is still worthwhile. Doing this every year really adds up and savings on capital gains taxes down the line.
The backdoor ROTH is not a type of account, it is more so a strategy.
So how do you do it?
To complete a backdoor Roth, you put money into a traditional (nondeductible) IRA and then convert it over to your Roth IRA. It really is just one added step.
The key though is you have to use a nondeductible IRA. All this means is that when you put money into the IRA, you cannot deduct it when you file your taxes. This should be no problem since your income would be well above the allowed amount.
If you deducted your traditional IRA contributions and then decide to convert to Roth, you’ll need to pay taxes.
Here’s the exact 3 steps you need to know to do it:
1. Open and traditional IRA and Roth IRA
2. Contribute money to a traditional IRA
3. Convert the funds in your traditional IRA to a Roth IRA (but remember, do not deduct it)
4. Invest those dollars
5. Report your Backdoor Roth IRA contribution on your own form 8606
You have up until the tax filing deadline in the following year to complete it for the prior year. All this means is that you have till April 15, 2025 to get your $7,000 in for 2024.
The pro rata rule is something you have to be aware of.
It is important to know that you do not want to have other pre-tax IRA’s when doing the backdoor Roth.
Why?
Because you cannot choose to just use the nondeductible IRA dollars. The IRS looks at it on a pro rate basis.
So... if you have pre-tax funds in:
Then it leads to taxation.
Notice I did not say 401(k)s, 403(b)s, 457(b)s, Roth IRAs, or inherited IRAs.
If you have other funds in other pre-tax accounts besides a 401(K), then the pro-rata rule comes into effect.
Here's an example:
If all of your traditional IRAs combined to $7,000 and then you tried to do the backdoor Roth with $7,000 through a nondeductible IRA contribution then the pro rata rule would kick in.
It would say $7k/$14k (pre tax vs total IRA balance) = 50%.
So half of the backdoor Roth would be taxable and count as income.
Why?
Because you cannot choose to convert only after tax /non deductible money.
To help you avoid the issue above, you can roll any old IRAs into your current 401k, 403b, solo 401(k) etc.
This is exactly why it is critical that you DO SOMETHING with any IRA balance you have PRIOR to December 31st of the year in which you do a Roth conversion of after-tax money or you will owe taxes.
This is the basics in understanding backdoor ROTH IRA’s, who can use them, & how!
Hope this helps!
Financial Advisor