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.
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.
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.
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