Ask the CFP®: What is a Backdoor Roth IRA?

Welcome to this month’s Ask the CFP® segment. Today, we are going to discuss a financial strategy that could have a positive impact on your retirement planning: the Backdoor Roth IRA.

Now, you might be wondering, what exactly is a Backdoor Roth IRA? Let me break it down for you…

If your income exceeds the limits for direct Roth contributions, but you still want to contribute to a Roth IRA to enjoy its tax benefits, that’s where the Backdoor Roth IRA comes into play.

Here’s how it works:

First, you make a non-deductible contribution to a Traditional IRA. Since your income surpasses the threshold for direct Roth IRA contributions, this serves as a workaround. 

Keep in mind that this is limited to the maximum IRS contribution allowance, which in 2024 would be $7,000, plus another $1,000 catch up if you are older than 50.

Step two: After making the contribution, you convert the funds from the Traditional IRA to a Roth IRA. Yes, that’s a taxable event, but here’s the kicker: if you’ve only contributed non-deductible funds to your Traditional IRAs, the tax implications are typically minimal. Don’t forget that if you do have more than one IRA, some complexity is added to this strategy because the IRA Aggregation Rule says all of your IRA accounts need to be considered as if they were one IRA.

Here are a few key points to keep in mind:

  • The initial contribution to the Traditional IRA is non-deductible, but any earnings  on those contributions will be subject to taxes upon conversion. However, if you’ve only held the Traditional IRA for a short time, depending on the amount of earnings, the tax impact could be minimal.
  • Unlike direct Roth IRA contributions, there are no income limits for Roth IRA conversions. This makes the Backdoor Roth IRA strategy attractive for some high-income earners.

But remember, before you decide to use the Backdoor Roth IRA strategy, it’s important to consult with a financial advisor or tax professional who can provide personalized advice based on your financial situation and goals to avoid costly tax mistakes.

In summary, the Backdoor Roth IRA strategy can offer high-income individuals an opportunity to enjoy the benefits of a Roth IRA, including tax-free growth and withdrawals in retirement.

If you have a question for a future ask the CFP® segment, please send it to kluetters@monetagroup.com

Thanks for watching and we’ll see you next time.

© 2024 Advisory services offered by Moneta Group Investment Advisors, LLC, (“MGIA”) an investment adviser registered with the Securities and Exchange Commission (“SEC”). MGIA is a wholly owned subsidiary of Moneta Group, LLC. Registration as an investment adviser does not imply a certain level of skill or training. The information contained herein is for informational purposes only, is not intended to be comprehensive or exclusive, and is based on materials deemed reliable, but the accuracy of which has not been verified.

Trademarks and copyrights of materials referenced herein are the property of their respective owners. Index returns reflect total return, assuming reinvestment of dividends and interest. The returns do not reflect the effect of taxes and/or fees that an investor would incur. Examples contained herein are for illustrative purposes only based on generic assumptions. Given the dynamic nature of the subject matter and the environment in which this communication was written, the information contained herein is subject to change. This is not an offer to sell or buy securities, nor does it represent any specific recommendation. You should consult with an appropriately credentialed professional before making any financial, investment, tax or legal decision. An index is an unmanaged portfolio of specified securities and does not reflect any initial or ongoing expenses nor can it be invested in directly. Past performance is not indicative of future returns. All investments are subject to a risk of loss. Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets. These materials do not take into consideration your personal circumstances, financial or otherwise.

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