Roth IRAs: Going through the Back Door
Higher income earners are often disappointed when they realize they cannot contribute to a Roth IRA. After all, Roth accounts can be a great way to grow money and eventually take distributions on a tax-free basis (applicable rules must be adhered to). Fortunately, it’s not the end of the road, as anyone of any income level can still get money into Roth accounts using different strategies.
Converting money from an IRA to a Roth IRA may be done by anyone, anytime, on an unlimited basis. You’ll pay ordinary income tax on the amount converted in the tax year of the conversion, but it’s an alternative to a contribution. Some 401(k) plans have Roth options inside of them which are not limited merely by your income and may allow you to ultimately contribute more money than a Roth IRA would allow.
An intriguing strategy that works well for some, is what has been nick-named a “backdoor Roth IRA”. Essentially, if your income is too high for a Roth IRA contribution, you may make a non-deductible contribution to a traditional IRA and immediately convert to a Roth IRA. Since you have already paid taxes on the money (because you did not take the deduction), you can “backdoor” the transfer to a ROTH, only paying taxes on the growth that’s moved over, if there is any. Be sure that you know all the rules and consequences before you open the back door. For example, there are complications if you have other retirement money in addition to the newly non-deductible IRA contribution. Additionally, we’ve run projections for many clients who are likely better off making deductible contributions before retirement versus paying the taxes now. Options exist for your ROTH IRAs, including going through the back door.
LouAnn Schulfer of Schulfer & Associates, LLC Wealth Management can be reached at (715) 343-9600 or louann.schulfer@lpl.com. www.SchulferAndAssociates.com
Securities and advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.
Although this strategy has existed since 2010, the IRS has not officially commented or provided formal guidance on whether it violates the step-transaction rule. (When applied, this rule treats what are several different steps as if they were a single transaction for tax purposes.) Experts have mixed opinions on the likelihood of this happening, but the lack of a definitive ruling means there is some risk involved. If the IRS decides that the loophole is a violation, if restrictions do come into play at some point, they could require backdoor Roth converters to pay a penalty, or they might include a grandfather clause. There’s no guarantee the backdoor Roth IRA strategy will always be available. Congress recently considered legislation that would have eliminated the backdoor option. As of now, the backdoor Roth IRA is still around, but no one can predict its future. If you use this backdoor Roth strategy solely to sidestep the earnings limits on Roth, you need to be aware of the risks and seek the counsel and support of a tax professional. This information is not intended to be a substitute for specific individualized tax advice We suggest that you discuss your specific tax issues with a qualified tax advisor.
