Understanding Backdoor Roth IRA
TRICKS OF THE TRADE
Backdoor Roth IRA Strategies
Prepared by Michael Menninger, CFP
What is a Backdoor Roth IRA?
The “Backdoor” Roth IRA is a nickname given to a specific tax loophole that was born in 2010. In that year, the Federal tax laws were changed which eliminated the income limit (formerly $100,000 AGI) to convert IRA assets to a Roth IRA. However, the income restrictions for contributing to a Roth IRA remained in place.
Am I Eligible For a Backdoor Roth IRA? Contact Us
If My Income is Too High, Can I Still Get a Backdoor Roth IRA?
An individual whose income was too high to contribute to a Roth IRA was not excluded from contributing to a (non-tax-deductible) Traditional IRA. Thus, that same person contributed to an IRA, and then immediately converted that IRA to a Roth IRA. That individual was responsible for paying tax on any portion that was previously tax-deductible, or tax-deferred, but there wasn’t any! Thus, that individual effectively contributed to a Roth IRA, despite not being eligible based on their income. And voila, the Backdoor Roth IRA was born!
Speak with a tax planning strategist such as Menninger & Associates to go over your unique situation and needs.
Pro Rata Rule Backdoor Roth IRA
I discovered this loophole in January 2010, but it seemed too good to be true, so I ran it by the CPA I use for my taxes. He liked and agreed with my idea, but refined it with what I reference as a “pro rata rule” Backdoor Roth.
In short, the Backdoor Roth Pro Rata rule specifies that the amount of the Roth IRA conversion that is tax-free must take into account the total amount of IRA assets held by that individual. Thus, individuals who own IRAs may not be able to take full advantage of this Backdoor Roth IRA. One final thing to remember is that converting from a traditional IRA to a Roth IRA is a taxable event.
Learn the Difference Between Traditional and Roth
Are Backdoor Roth IRAs Legal?
Under present law, a Backdoor Roth IRA is legally permissible.
However, the tax rules are always changing so this information is for discussion purposes only and in no way represents legal or tax advice. For advice regarding your specific circumstances, the services of an appropriate legal or tax advisor should be sought.
Speak with your tax advisor or financial advisor to see if the Backdoor Roth IRA makes sense for you. You can contact us to have a discussion on your planning philosophy.
Contact Menninger & Associates For More Information
Tax Planning Strategies Explained
Menninger & Associates are Certified Financial Planners that can assist with your tax planning strategies and other comprehensive financial solutions. We offer a variety of resources, such as our Financial Planning Explained YouTube videos. In this video, watch as our team discusses Backdoor Roth and other frequently asked questions about finances. We are always providing new opportunities to educate our clients, so use this link to submit a question that could be the topic of our next discussion!
About the Author: Michael Menninger, CFP®️
Michael Menninger is the founder and president of Menninger & Associates Financial Planning. With 20+ years of financial planning experience, Michael helps his clients pursue their financial goals through a hardworking, common-sense and detail-oriented approach to financial planning. He provides personalized service, builds lasting relationships, and maintains a disciplined, long-term outlook. He uses his experience and wide-ranging business and educational background as a basis for creating financial plans unique to each client's goals and aspirations.
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