Above the Income Limitations for Contributing to a Roth IRA? Consider the Backdoor.

Ever since their creation in 1997, Roth IRAs have been an effective way to save for retirement. Because they allow post-tax contributions to both grow tax-free and be withdrawn tax-free, financial experts encourage clients to maximize Roth contributions throughout their working years. 

However, not everyone is eligible to contribute directly to a Roth account. For these individuals, annually completing a Backdoor Roth can add depth and stability to a retirement plan.

Here more on how you might use the Backdoor option to your advantage, courtesy of True North Wealth, Utah County’s leading fee-based financial advisors.

Who Can Benefit from a Backdoor Roth? 

With the creation of Roth IRAs came certain income limitations regarding who could contribute directly to these accounts. In 2019, this restriction applies to anyone with a yearly income of over $193,000 (for those married filing jointly) or $122,000 (for single filers). For this reason, many high earners assume that they cannot reap the benefits associated with Roth accounts.

However, as of 2010 there is no restriction on who can convert money from a traditional IRA into a Roth IRA. This conversion process is referred to as a Backdoor Roth, and for high earners, it is an effective strategy to still secure tax-free growth and withdrawals. 

How The Backdoor Works

Although the concept of a Backdoor Roth is foreign to many, the process is fairly simple, as shown in the infographic below: 

The Backdoor Roth can be broken down into three basic steps.

  • Step 1: In order to avoid tax complications, make sure that you do not have any existing pre-tax IRA accounts with assets in them.

  • Step 2: Make a non-deductible contribution to a traditional IRA. For 2019, the contribution limit for IRAs is $6,000 a year, and you will want to contribute the maximum to make this strategy effective.  

  • Step 3: Convert that money into a Roth IRA, where it can grow tax-free and eventually be withdrawn tax-free.

Benefits of the Backdoor Roth Strategy

In addition to the obvious benefits of tax-free accounts, the power of tax diversification cannot be ignored. When you are preparing to retire, you will find that having money in a combination of taxable, tax-deferred, and tax-free accounts will give you a tremendous amount of power in controlling your taxable income during retirement. It will give you the luxury of using taxable accounts first and saving your tax-free accounts for later. 

Additionally, the tax-free benefits of an IRA will benefit both you and any heirs that inherit your account.

Thus, it is clear that Roth accounts can be a powerful tool in building and securing wealth. For those above the income limitations, the best way to do this is through the Backdoor. Consistently completing a Backdoor Roth and investing that money aggressively will ensure that your Roth IRA reaches a substantial size by the time you retire. 

For more information or to put the services of our fee-for-service financial advisors in Utah County to work for you, give True North Wealth a call today.