Denise Appleby: How The Backdoor Roth IRA Contribution Works
- Date: September 11, 2020
How The Backdoor Roth IRA Contribution Works
How The Backdoor Roth IRA Contribution Works
by Denise Appleby, CISP, CRC, CRPS, CRSP, APA
How The Backdoor Roth IRA Contribution WorksBy: Denise Appleby, MJ, CISP, CRC, CRPS, CRSP, APA If you believe that income tax rates will increase in the future- as many finance and tax experts do- then you will agree that the Roth IRA is often a better choice than the traditional IRA, if the objective is to choose the one that results in the lower income tax. But what if you are not eligible to make a regular contribution to a Roth IRA, because your income is too high? You can get around that limitation by using the backdoor Roth IRA contribution strategy. Why Roth IRAs Are Attractive Like traditional IRAs, earnings in Roth IRAs grow tax-deferred. But unlike traditional IRAs, where distributions of earnings are subject to ordinary income taxes, distributions of earnings from a Roth IRA are tax-free as long as you are eligible for a qualified distribution. Your distributions would be qualified if you meet the following two requirements:
The Income Limitation On Roth IRA Contributions One of the ways in which a Roth IRA can be funded is by making regular IRA contributions. Unlike traditional IRAs which are not subject to income limits, you are eligible to make a contribution to a Roth IRA only if your modified adjusted gross income (MAGI) does not exceed the following amounts: 2018 MAGI Limits
2019 MAGI Limits
The Two Steps To A Backdoor Roth IRA Contribution The backdoor Roth IRA contribution is a strategy and not a product or a type of IRA contribution. Therefore, you shouldn’t ask your IRA custodian or trustee for a backdoor Roth IRA contribution. Instead, you should take the following steps: Step 1: Make Your Contribution To A Traditional IRA Remember, you are eligible make a contribution to a traditional IRA, only if you are under age 701⁄2 as of the end of the year for which you make the contribution. For instance, you are eligible to make a regular contribution to a traditional IRA for 2019, only if you will not reach age 701⁄2 on December 31, 2019. You are considered to have reached age 701⁄2 six months after your 70th birthday. Your regular IRA contribution cannot exceed the lesser of:
If you have no basis in your traditional IRA, then your Roth IRA conversion will include only the pre-tax amount and therefore fully taxable. Your IRA custodian/trustee will report your Roth conversion as fully taxable even if a portion of the amount is attributed to basis and should be tax-free. This is because they have no way of knowing how much of the amount is attributed to basis. However, your tax preparer is required to file IRS Form 8606 to let the IRS know how much of the conversion includes basis. Keep A Record Of Your Roth IRA Activity If this is your first Roth IRA, keep track of the year, so that you will know when your five- year period for ‘qualified distribution eligibility’ begins and how much of your Roth IRA balance is attributed to basis. You should also ensure that IRS Form 8606 is filed for every nondeductible contribution that you make to your traditional IRA, and for every distribution that occurs when any of your non-Roth IRA balances include basis. Denise Appleby is CEO of Appleby Retirement Consulting, Inc., a firm that provides a wide range of retirement products and services to financial, tax, and legal professionals. The firm’s primary goal is to help prevent mistakes from being made with retirement account transactions; and, where possible, provide solutions for mistakes that have already been made. Their products include IRA guides and other IRA educational tools for financial and tax professionals. Denise is also creator and CEO of the consumer education website www.RetirementDictionary.com. ©Copyright 2020: Appleby Retirement Consulting Inc. Grayson, GA. Provided for educational and general informational purposes. Cannot be used as tax or legal advice. For professional use only. |
Nicole Maholtz: 2019 IRA Plan Limits
Profile More