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The Rundown on Back-Door Roth Conversions

Go ahead and breathe a sigh of relief, for now. Congress isn’t showing signs of taking any further action to terminate backdoor Roth IRA conversions. That said, let’s review the basics of a Roth IRA account and why it’s worth considering: 

  • The max annual contribution you can make into any IRA, Traditional or Roth IRA, in 2022 is $6,000 ($7,000 if you’re age 50 or older). For a married couple, both spouses can fund that amount. 
  • A Roth IRA contribution doesn’t give you a tax deduction today (like a traditional IRA does). However, the Roth IRA will grow and distribute tax free (i.e. you’ll never pay taxes on the money again!). Although your income may be less in retirement, general tax brackets may be higher. We love Roth IRAs because it adds more “tax diversity” to your investment accounts. 
  • Unlike a 401k or Traditional IRA, the Roth IRA has no required minimum distributions (RMDs) at age 72. This allows your Roth IRA to compound and grow tax-free for a very long time, well into retirement. It’s an excellent “last bucket” account to dip into in your last decade of life. 
  • If you need to withdraw funds, you can always pull your contributions (not the gains) from a Roth IRA without incurring the 10% penalty. 

How does a backdoor Roth IRA conversion work?

When your income exceeds a certain threshold ($144,000 for single and $214,000 for married filing jointly in 2022) a direct contribution into a Roth IRA is no longer allowed. However, a Traditional IRA contribution of up to $6,000 ($7,000 if you’re 50 or older) is always an option regardless of income levels and deductibility. It’s also always an option to convert funds held in a Traditional IRA account to a Roth IRA account. This creates a “backdoor” route by funding a Traditional IRA, and immediately converting/transferring those funds into your Roth IRA.

You should make the conversion immediately after funding the Traditional IRA because if gains accrue prior to converting, there are taxes to pay upon converting. Other technicalities exist when there are already funds sitting in a Traditional IRA, so it’s important to consult with your advisor and develop the right strategy.

The deadline to make your 2021 Traditional IRA contribution is April 15th, 2022. If there’s cash surplus on hand, now is a good time to jump on your 2022 contribution as well. Remember to then make the Roth Conversion immediately after funding the Traditional IRA. If you’re a client of PracticeCFO, it’s likely we’re handling the administration for you each year with very little effort on your part.

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