Should We Consider a Backdoor Roth Strategy this Year?

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What is a ‘Backdoor’ Roth?

A ‘Backdoor’ Roth IRA is a strategy used for people and families who make over the $230k Joint, $146k Single income limit to contribute to a Roth IRA.

Why Use This:

  • Tax-Free Distributions and Tax-Deferred Growth: Roth IRA’s grow tax-deferred, and are distributed tax-free. The only taxable portion is the contribution is made with after-tax dollars. Traditional IRAs are Tax-Deductible up-front, grow Tax-Deferred, but upon distribution, are taxable at ordinary income tax rates. To diversify the tax distributions at retirement, some families prefer to have different options.
  • Estate Planning: While Traditional IRAs are subject to the 10-year rule (heirs must distribute the IRA within 10 years, or be penalized), Roth IRA’s have no restrictions on withdrawals for beneficiaries, for the most part.

How to use:

The strategy is simply:

  1. Contribute up to the annual maximum of $7k (2024) to a Non-Deductible Traditional IRA
  2. Convert the Non-Deductible Traditional IRA to a Roth IRA
  3. Fill out tax form 8606 for the Tax Filing Year to report the Conversion

When to use:

  • When AGI is above $230k JT or $146k Single
  • You’ve maximized your Pre-Tax Contribution Retirement Savings Goals

When not to use:

  • The 5-year Rule: If you are nearing Retirement Distribution Phase, the 5-year rule on Roth IRAs could leave you in a lurch. This Roth IRA distributions rule stipulates the earnings of a Roth IRA may not be distributed in the first 5-years of your first Roth IRA contribution (one may take principal whenever one pleases for whatever reason).
  • Pro-Rata Rule: If you have a Traditional IRA, each dollar withdrawn or converted from an IRA or 401(k) will contain a percentage of tax-free and taxable funds relative to the proportion those funds make up the account.
  • Legislation Risk: There has been talk each of the past few years about removing the ‘Backdoor’ Roth IRA Strategy.




Citations: 
1.  Roth Iras. Internal Revenue Service. (2024, August 8). https://www.irs.gov/retirement-plans/roth-iras

 

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