5 Considerations When Funding a Back Door Roth IRA

Wealth Advisor

Here are five key things to be aware of when considering a backdoor Roth IRA:

  1. Inherited IRA Exception: If you have an inherited IRA and no existing IRA balance of your own, the aggregation rule doesn’t apply, making it easier to do a backdoor Roth IRA.
  2. Married Filing Separately: Couples filing separately with an AGI over $10,000 may need to use the backdoor Roth option, especially if one spouse’s income exceeds the Roth IRA threshold.
  3. After Tax 401(k) Contributions: If your employer’s plan allows after-tax 401(k) contributions, you can convert the after-tax contributions to a Roth IRA, offering tax-free growth.
  4. SEP IRA Strategy: Self-employed individuals can contribute to a SEP IRA, take a deduction, and then immediately convert it to a Roth IRA in the same year, creating a tax-neutral move.
  5. Spousal IRA: A spouse with earned income can contribute to an IRA for their non-working spouse, making it possible for both spouses to maximize their Roth contributions even if one has no income.

Using these strategies, you can efficiently contribute to a Roth IRA, taking advantage of tax-free growth and greater control over your retirement savings.

Video Transcript

Here are five things to be aware of if you are doing a backdoor Roth IRA. Quick background, backdoor Roth IRA is a loophole in the tax code, totally legal way to, if you’re over the Roth IRA threshold, so it’s a married filing jointly couple in 2022, that is around $200 ,000, meaning if you make over $200 ,000, you begin to get phased out of direct Roth IRA contributions.

So household incomes, $500 ,000, you are not able to directly contribute into a Roth IRA, but you can do what’s called a backdoor Roth IRA, which makes a non -deductible after tax contribution into IRA and immediately convert that into Roth for a tax -free transfer, and all the money in the Roth continues to grow tax -free forever.

The one thing that you do wanna be aware of is if you have an IRA balance, so if you have an IRA balance of a million dollars and you go to do the backdoor Roth is called the aggregation rule, which is a tax code that says a portion of the money that’s converted into Roth is then gonna become taxable because a lot of that IRA balance is taxable.

So here are five things to be aware of. The first one is if you have an inherited IRA, that aggregation rule does not come into play, so if you’ve inherited a million dollars in an IRA from a parent and you don’t have your own existing IRA balance, you are able to do a backdoor Roth IRA, and that does not affect you or make any of that money that gets transferred into the Roth taxable.

Second thing is that if you are a couple that’s married filing separately, one common reason for this is if there are student loans or a couple is qualifying for public service loan forgiveness, they may be filing separately to keep your student loan payments down, but if you are married filing separately and your adjusted gross income is over $10 ,000, you would have to do a backdoor Roth, so if one spouse is over the IRA, the Roth IRA threshold, they’re making 250 a year, other spouse is making $100 ,000 a year for the married filing single, phase out of the Roth IRA is around 120 ,000, so that spouse that’s under the single threshold would have to contribute into a backdoor Roth because their AGI is over $10 ,000.

Third thing to be aware of with a backdoor Roth is any after tax IRA or after tax 401K money can be converted into a Roth, so some employer plans allow you to make after tax 401K contributions, so you don’t take a deduction on it.

The contributions are always after tax and not taxable, but any of the growth you would pay and come tax on it whenever it’s distributed. Some plans are able to roll the after tax money, do an in -service rollover from the 401K into the Roth IRA and really take a sniper shot of that after tax money that any of the growth is forever gonna be taxable, move that into the Roth IRA and then all of the growth will be forever tax -free.

If there is any growth, obviously that would be taxable when it’s transferred to the Roth IRA. Fourth thing to be aware of is if you are a self -employed business owner or you have any 1099 income, consulting income, and you’re contributing into a SEP IRA, a SEP IRA would count as aggregation as we talked about in the first.

So you have a SEP IRA balance of 100 ,000, you go to do a backdoor Roth, aggregation comes into play, but you can contribute into a SEP IRA each year, take the tax deduction. If you contribute $20 ,000 into the SEP IRA and that limit is 25% of whatever your 1099 income or business income is, contribute $20 ,000 in that tax year, take the tax deduction and then immediately the same year convert it into a Roth IRA.

Gets reported on the tax terms as a deduction and then a Roth conversion. So it is a tax neutral move, you do not get taxed on it as long as there’s no growth in that time period of when you make the contribution to convert it.

So there’s another way to get additional money into a Roth if you are self -employed or have any 1099 income. And the fifth thing to be aware of is what’s called a spousal IRA. You have to have earned income to be able to fund any IRA.

It has to be over $6 ,000 to max out the Roth IRA if you’re under the age of 50, but if one spouse works, makes 500 ,000 a year and the other spouse stays at home has no income, the spouse that stays at home obviously doesn’t have an income over $6 ,000, but they are able to contribute and do a back door Roth through it, what’s called a spousal IRA, which means as long as one spouse has earned income, the other one can contribute and max out the IRA.

EWA were big proponents of getting money into Roth. Number one for tax -free growth, number two, there’s no requirement of distributions. So you get into retirement, you don’t have to take money out if the market’s down. And the third way, third reason is autonomy.

You have total control over when you take the money out in retirement or after the conversion’s been made within after five years, you’re able to pull your basis out. So five things to be aware of if you are doing back door Roth IRAs and reach out if you have any questions.

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