Written by Today, we’ll answer the question. What is a backdoor Roth IRA? In this episode, we’ll talk about some of the drawbacks and benefits, whether it’s legal, whether it makes sense and why some people are doing it. Most entrepreneurs and families worry about money. So we created the wisdom metric framework which shows you how to build multiple streams of income, so you can enjoy life without financial worry.
Intro to Backdoor IRA
So when it comes to a backdoor Roth IRA, first and foremost, it’s not like different than a Roth IRA. What I mean is there’s not like a category where if you were to go open an account, you would say, I want to open a backdoor Roth IRA. It is just your IRA and your Roth IRA are the choices. What a backdoor Roth IRA is, if you are someone who exceeds the income limits and currently what that is in 2022, it’s $144,000 for an individual.
And It is $214,000 for joint couples. If you make more than that you’re not able to fund or have a Roth IRA. So what ends up happening is if you were to say, okay, well, I’m going to try to find a way to make one. You would come across this idea of a backdoor Roth IRA. And the way that works is you would put the money into your regular IRA, and then you would convert it into a Roth IRA.
Is It Legal?
And this strategy is completely legal. The IRS is totally fine. And what ends up happening is you would still pay the taxes. So what I mean is if the money you put inside of your regular IRA was taxable income. Well, then you would be taxed on the gains because it’s already been taxed when you put the money in, so they wouldn’t worry about it.
But the majority of you are going to have IRAs that have tax deferred, where the money was put in before it was. So if you turn that into a Roth IRA, by taking advantage of a backdoor Roth IRA strategy, well, then you’re going to pay taxes on the income that was put in it because you haven’t paid taxes on it yet.
You will also pay taxes on the growth as well. So the entire account could be a taxable event for you. now some of the reasons that you would want to do it because you’re going to be like, well, Dre, I’m going to be taxed on the whole thing.
Why would I want to do it?
Well, just like your regular Roth, it’s now money that’s going to grow tax free. And another benefit is it doesn’t have the required minimum distributions that your traditional IRA would have. And so what that means is if your money’s growing tax free and you don’t have to pull it out any particular time. This money could grow and grow.
When it comes to having some money, that’s growing tax free, all things being equal, tax free money is going to outgrow tax money. And so that is going to be an advantage that you want, that you want to have in your retirement strategy. Also, when it comes to having a backdoor Roth IRA. If you said, okay, well, I want to be able to pass this money on to my legacy, like my kids and different things.
Does it feel right?
Well, now you have this money set inside of a tax free instrument. And then when that grows and then it just completely goes to them when you pass, because as long as you’re alive, that money’s going to continue growing tax free. So that’s going to be something that will benefit your legacy planning as well. So when you’re now saying, okay, well, Dre, this doesn’t feel right.
Like, I feel like I’m doing something that I shouldn’t be doing well, again, that’s not the case. The IRS is well aware of this. And they said, it’s totally fine. They’re totally cool with it currently. Now with that said in 2021, I think it was like November 19th, 2021, HR 5376.
Build back better infrastructure plan
Which we know as the build back better infrastructure plan inside of that, there were some changes to the back door Roth IRA. Some of the main ones included, and It says that there would be limits in the contributions and require increased distributions of taxpayers accounts exceeded to million dollars in 2029.
And ultimately it would eliminate the ability to use the backdoor Roth IRA by 2032 for higher income individual. Now higher income individuals, it’s basically going to be anyone that makes roughly around like $400,000 or more per year as an individual or roughly around $450,000 per year jointly. If you were someone who fell into that category, then the back door Roth, IRA strategy was on the table to be removed for you.
It may not be around forever
So I say that to say that there’s already discussions around it. Now the build back better plan. It wasn’t passed in the Senate, even though it was passed in the house. So it’s not something that you currently have to worry about, but it is just putting on a new radar that there were some tweaks that were going to be done to it based on the certain amount of income that you had as far as not being able to use it.
And then based on once the account passed a certain amount of money, then it would change the way that it was looked at by the IRS based on this law. But currently that’s not the case. Currently everything is still open in the sense that the only requirement is you put the money inside of a traditional IRA, and then you can roll over those contributions or the entire account into a Roth IRA, which would be the back go Roth IRA strategy.
Income Limits
Now for you when it comes to that, you may decide that it just makes the most sense for you to roll over a portion of it. You may decide it makes the most sense for you to roll all of it over. That’s going to be something that will be decided right on an individual basis. Whatever makes the most sense for you.
But if you’re someone who doesn’t qualify based on the income limits that a regular Roth would have, and that would be $144,000 for an individual, $214,000 for a joint couples. Then you’d want to look into the backdoor Roth strategy. Another benefit that you find is there are contribution limits of how much you can put in each year, your traditional IRA and your Roth.
They both have the limits of $6,000 a year, but if you roll it over, your rollovers don’t have that same requirement. So if you had money that you had in a Roth, and maybe you decided that you wanted to have. Traditional IRA for like several years. And it’s grown to hundreds of thousands of dollars.
You could roll that all into a Roth IRA and not have any issues at all. It doesn’t have the same income limits that you would have when you’re doing a rollover. So that’s another advantage for you.
Final thoughts
So in closing, when it comes to you deciding, does it make sense for me to take advantage of a backdoor Roth IRA?
The first question that you’re going to answer is do I make more than the traditional limits? Do I make more than $144,000 as an individual? Or do I make more than $214,000 as a joint couple? The next one is, you know, basically I think once you say yes to that, then it just would make sense for you to take advantage.
You do need to consider the fact that there has been legislation that was passed in the house that was being considered in the Senate, that would change the ability for you to take advantage of a back door Roth, the way that we know it today. So it is something that you want to have in your thought process when it comes to that.
What’s your current strategy?
But currently it is a strategy that is available that you can take advantage. And if you don’t have the ability to take advantage of the traditional through the traditional limits, then I encourage you to look and explore the options when it comes to just having tax free income, growing for your retirement.
It’s something that you could take advantage of and open with an advisor. It’s something that you could really call many of the brokerages and they can help you and walk you through the process as well. It is something that you could do on your own if that makes sense to you.
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