What is a “Backdoor Roth IRA” and what are its benefits?
If you’ve been looking into various ways to save for retirement, you’ve likely heard that an IRA is a great way to go. There are both Traditional and Roth IRAs, both of which are great investments for long term saving. The main difference between the two is that a Traditional IRA is funded with pre-taxed dollars, but your money is eventually taxed at the time of withdrawal. A Roth IRA, on the other hand, is funded with taxed dollars but withdrawals are tax-free. Then there’s another option called a “backdoor Roth IRA.”
What is a backdoor Roth IRA?
A backdoor IRA is a sort of loophole around the limits usually imposed on a Roth IRA. Starting in 2019, if you make more than $137,000 as an individual or $203,000 when filing jointly, you’re not generally supposed to be able to make contributions to a Roth IRA.
Even if you are eligible to contribute to one, you can only fund it with $6,000 (or $7,000 if you’re 50 or older) per year. Unless that is, you opt for a backdoor IRA, in which case you can get around both restrictions.
How does a backdoor Roth IRA work?
If you’d rather pay taxes on your retirement funds now and enjoy a tax-free future, then a backdoor Roth IRA may be the solution for you. Simply put, it merely involves converting a Traditional IRA to a Roth IRA.
Don’t worry, it is totally legal. But it isn’t a tax dodge either. When the time comes for you to make the conversion, you will have to pay taxes on the money in your Traditional IRA before it’s officially switched over to a Roth.
Is a backdoor Roth IRA for you?
While the backdoor Roth IRA is a great investment loophole, it’s only going to make sense for a select group of people. It may be for you if you’re either earning so much money now that you aren’t eligible for a Roth IRA and/or can foresee yourself falling within a higher tax bracket when you retire or turn 70.
If you think it may be a helpful solution, however, your bank or financial advisor should be able to easily guide you through the process.