How to do a Backdoor Roth IRA Conversion [Video]

Today, we are going to talk about the Backdoor Roth IRA strategy.

This strategy is designed for people who make too much money to directly contribute to a regular Roth IRA. We are going to talk about why you would want to contribute to a Roth and how you can do that if your income is too high.

Roth IRA Contribution Limits

Now what do I mean by “your income is too high?” If you are a single filing tax payer and your income is over $145,000, then your income is too high to directly contribute. If you are married and your income is over $215,000, same thing. The IRS income limit rules do not allow you to contribute to a Roth IRA.

Now one thing we always tell people to confirm before you pursue a backdoor Roth IRA strategy is to make sure you are already maxing out your 401(k). The backdoor Roth IRA strategy is really designed to allow you to save above and beyond your 401(k). Finally, and very important, is that you do not have any money in a traditional IRA account in order to do this strategy. I am not going to get into all the details of why that is in this video, but you can read all about it in this comprehensive article! So with all that in mind, let’s jump right into this strategy. 

Understanding the types of IRAs 

It’s important to understand the difference between the two individual retirement account (IRA) choices. In a Traditional IRA, you can put money in and get tax deferred growth, as long as the money is in the account. But, when you go to take the money out, the IRS forces you to pay income tax on it. So, when you take the money out, you won’t get the money dollar-for-dollar. It will be reduced by taxes you have to pay. 

A Roth IRA on the other hand, allows you to get the tax free growth over time. And, when you pull money out, you will get everything dollar-for-dollar. They don’t tax this at all. So this makes the Roth IRA a really great long term savings vehicle for retirement. The problem, as I alluded to before, is the IRS puts income limits on who can actually contribute to a Roth IRA. 

Again, if you are single, making over $145,000, or married, earning over $215,000, you can’t put money directly into a Roth IRA. But there is a way to get around this, and that’s what we are going to focus on, and it’s really only two steps.

The Backdoor Roth IRA Conversion 

Step One

The first step is you have to make a non-deductible contribution to a Traditional IRA. You heard that right – a Traditional IRA. Even though we are trying to get money into a Roth, this is how we start doing that. The IRS income limit says you can’t contribute to a Roth IRA directly. But they don’t have those limits for a Traditional IRA. You can contribute to a Traditional IRA anytime. The only rule is that if your income is too high, they won’t give you a tax deduction. So, because your income is really high, and you can’t do a Roth IRA contribution, you are still allowed to contribute to a Traditional IRA, but it will be non-deductible. 

Step Two 

Once that money is in there, we move on to step two. What you do now is convert that Traditional IRA to a Roth IRA. You put $6,000 into a Traditional IRA, and you immediately convert it to a Roth IRA. You get to keep the full $6,000 dollar-for-dollar! Those are really the only two steps. 

So, what do you need to be able to do this? You need a Traditional IRA and a Roth IRA. Usually we recommend you open these at the same bank or custodian, just to make the process really smooth. 

Why do a Backdoor Roth IRA Conversion?

Now you can see here that you accomplished exactly what you would have been able to do if your income wasn’t too high. If your income wasn’t above the Roth IRA contribution limits, you would just take your $6,000 and put it right in the Roth IRA. But since your income is too high, you have to do that one extra step of adding the money into a Traditional IRA first before it can be added into your Roth IRA.  

One question people often ask as we explain this strategy is “is this even legal”? Don’t worry, it is! I don’t know why the IRS allows you to contribute this way, but not the regular way. That is how the rules are set up. 

A lot of financial planners, including us, have been helping high income earning clients with this strategy for a long long time. As long as the rules allow it, we will consider this strategy! 

Your Next Steps

If you want want to learn more about Roth IRAs or retirement saving strategies, read our article here! Or if you want help sorting out your finances, including your retirement accounts, read about our retirement planning.