Backdoor Roth IRA Contributions

There are income limits on contributing to a Roth IRA. Taxpayers whose incomes are above these limits can get around these limits with the backdoor Roth IRA strategy. Using this strategy, a taxpayer contributes to their traditional IRA account and converts the amount to their Roth IRA account. There are no income limits on contributing to a traditional IRA account (though such a contribution may not be tax deductible). Under the current tax law, and for the past 10 years, there are no income limits on converting an amount from a traditional IRA to a Roth IRA, though this may result in recognizing income tax as discussed below.

It’s important to note, when you convert an amount from a traditional IRA to a Roth IRA account this is a taxable event that may result in recognizing taxable income.

If you have a traditional IRA, SEP IRA, or Simple IRA that has an existing balance, that balance is likely from making tax-deductible contributions and earnings in the account. When converting an amount to a traditional IRA to a Roth IRA, you must look at it as if you’re converting a portion of all the balances in your traditional, SEP, and Simple IRA accounts to the Roth IRA, even if the traditional, SEP, or Simple IRA accounts are held at a different brokerage. You’re not able to pick and say the amount you’re converting is only X amount from Y account.

As a result, the backdoor Roth IRA strategy is best suited for taxpayers that don’t have existing balances in traditional, SEP, or Simple IRA accounts.

As an example if you have $100,000 in a traditional IRA account from tax-deductible contributions and earnings from prior years, and you contribute $6,000 to the traditional IRA for the 2021 tax year (which you don’t plan on deducting on your income tax returns), and convert $6,000 to your Roth IRA in 2021: the majority of the $6,000 converted to your Roth IRA is taxable. You should view this amount as a portion of the $100,000 of pre-tax contributions and earnings. The actual calculation to determine the taxable amount of the conversion is $100,000 / $106,000 X $6,000. The non-taxable amount of the conversion is $6,000 / $106,000 X $6,000. In this example, $100,000 is also the ending balance of the traditional IRA account on December 31, 2021, which is used in the calculation shown.

Contact me to discuss this topic in further detail

Please note: the information on this website is intended to provide general advice to start the discussion with your tax professional. The information on this website may not apply to your specific situation. Only an experienced professional with the details of your specific situation can advise you on making the best decision. Contact me or your tax professional to discuss the information on this site to make an informed decision.