Ask Clark: What Is a Backdoor Roth IRA?

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Want to contribute to a Roth IRA, but concerned that you earn too much money? Don’t fret, high-income earners still have a way to do it using something called a backdoor Roth IRA!

What Is a Backdoor Roth IRA?

Traditional IRAs are a more common investment choice than Roth IRAs. According to the most recent research by the Investment Company Institute, nearly 26% of U.S. households owned a traditional IRA versus just 17% who owned a Roth IRA.

It seems that for many, the lure of the upfront tax break from a traditional IRA is more appealing than the long-term tax benefits associated with a Roth IRA!

“Sometimes I hear people worry about a future Congress coming along and cheating people by taxing Roth accounts in retirement,” money expert Clark Howard says. “Well, anything is possible, but it’s not something I actively worry about.”

With Roth IRAs, you’re allowed to contribute up to $6,000 each year ($7,000 for those 50 and older). There’s no upfront tax break like there is with a traditional IRA. But a Roth can be spent tax-free in retirement, unlike a traditional IRA.

As of 2019, people who earn above $137,000 as a single person or more than $203,000 as a married couple filing jointly can’t do a Roth, according to IRS regulations.

If you earn more than that, you might think you’re out of luck. But you’re not! A backdoor Roth IRA can help. A backdoor Roth IRA is simply a name for the process of taking money in a traditional IRA, converting it to a Roth and paying the tax on it. It also goes by the name of a non-deductible IRA.

Who Can Do a Backdoor Roth IRA?

High-income earners can choose to open a non-deductible IRA, up to $6,000 ($7,000 if you’re 50 or older).

If you earn above $137,000 as a single person or more than $203,000 as a married couple, you’re potentially a candidate to do this. All you need to do is get in touch with your brokerage house and they’ll walk you through the steps.

Outside of just income standards, how do you know if you’re a good candidate to move regular IRA money into a Roth?

Consider it if you are younger (specifically under 40) and have a traditional IRA and the free cash to pay the earnings tax. In addition, any wealthy retirees facing required minimum distributions should consider doing this, too.

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But if you are on the cusp of retirement, there’s really no point to convert to a Roth — especially if you have a pension and other sources of income.

Final Thought

Doing a backdoor Roth conversion can make sense in the right situation. Just be sure to consult with a tax professional before doing this.

But no matter how you slice it, it’s probably a good move to insulate your nest egg from higher taxes down the road.

“Remember, in general, tax rates are likely to go higher over the years no matter which political party is in power,” Clark says. “That means it may make more sense to skip the deduction of a traditional IRA now to avoid tax later with a Roth IRA.”

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