Insights + Resources

Backdoor Roth IRA

May 20, 2020

Padlock open on backdoor fence
If you make too much money to open a Roth IRA, you could create one this way

You can sum up the appeal of a Roth IRA in three words: federal tax benefit. Potential earnings in a backdoor Roth IRA grow tax free as long as the owner abides by the Internal Revenue Service (I.R.S.) rules, and withdrawals are federally tax free once you reach age 59½ and have held the Roth IRA for at least five years.1 

Unfortunately, some people make too much money to contribute to one. In 2020, joint filers with modified adjusted gross incomes (MAGI) of $206,000 or more and single filers with MAGI of $139,000 are not eligible for a ROTH IRA.

There is a way for high earners to bypass these limits, however: the backdoor Roth IRA strategy.2

High-income taxpayers may create Roth IRAs indirectly. This involves a little maneuvering, but may be of interest to certain investors.

The backdoor Roth IRA strategy typically starts with the creation of a traditional IRA. The contributions to this new IRA are usually non-deductible, because of the IRA owner’s high modified adjusted gross income. This new traditional IRA is fully or partly funded, and with a financial professional’s help, it is quickly converted to a Roth IRA, and any tax liability is paid.3

Why does speed matter in this strategy? Well, the longer it takes to convert the traditional IRA into a Roth IRA, the greater the potential earnings of that traditional IRA. Since any traditional IRA earnings converted over to the Roth represent taxable income, those earnings should be minimal if the transfer is completed shortly after opening the account. (In the above example, the IRA contribution is made with after-tax dollars, so the initial contribution amount is not subject to federal taxes.)3

Keep in mind this article is for informational purposes only. It’s not a replacement for real-life advice, and a professional should be consulted before attempting this type of strategy. If you need to, reach out to your dedicated team at Epic Capital for additional information. Also, tax rules are constantly changing, and there is no guarantee that the tax treatment of Roth and Traditional IRAs will remain the same.

Plusses and minuses. The big attraction is the potential for tax-free retirement income, not to mention tax-exempt growth for the account. In addition, while mandatory annual withdrawals are required from traditional IRAs starting at age 72, no mandatory annual withdrawals are required from Roth IRAs while the original owner lives. Under the 2019 SECURE Act, most non-spouse beneficiaries of a Roth IRA are required to have the funds distributed to them by the end of the 10th calendar year following the year of the original owner’s death.5

Any Roth IRA conversion is a taxable event, and these conversions cannot be undone. That given, think about the basic rules for traditional IRAs. Generally, distributions from traditional IRAs must begin once you reach age 72, and the money distributed to you is taxed as ordinary income. When such distributions are taken before age 59½, they may be subject to a 10% federal income tax penalty.4,5

Tags: , , , ,

More Insights

Jul 22, 2021

The news keeps getting better for Social Security recipients. It’s now projected that benefits will increase 6.1% in 2022, up from the 4.7% forecast just two months ago. That would be the most significant increase since 1983.1,2

Jul 21, 2021

Inheriting wealth can be a burden and a blessing. Even if you have an inclination that a family member may remember you in their last will and testament, there are many facets to the process of inheritance that you may not have considered. Here are some things you may want to keep in mind if … Continue reading “Coping with an Inheritance”

Jul 19, 2021

It’s long been an aspirational target for entrepreneurs. It literally goes beyond “blue sky,” in terms of location, to a place no business has gone before: Outer Space! The name of the game is commercial space travel.

Jul 16, 2021

With all the attention given to inflation, stock prices, and job reports, it’s been easy to overlook the remarkable move in the bond market during the past few months as bond yields have fallen. The yield on the 10-year treasury closed at 1.37% on Friday, July 9, down from its 2021 high of 1.74% in … Continue reading “The Quiet Fall in Bond Yields”

Jul 14, 2021

On July 6, oil prices reached a six-year high of $76.98 a barrel. This benchmark came as the Organization of the Petroleum Exporting Countries (OPEC) and allies failed to reach an agreement regarding an increase in production.1 This rise in cost follows a year in which OPEC and allies cut production amidst the COVID-19 pandemic. … Continue reading “Oil Prices Hit Six-Year High”

Insights + Resources >