Backdoor IRA's

Roth IRA contributions are limited in eligibility based on your filing status and corresponding income. As a result, many folks don't believe they're allowed to contribute to Roth accounts. But there's a way around this limitation.....

For 2019, if you file married joint or your modified adjusted gross income is above $203,000 you're not eligible to contribute to a Roth IRA. There are limitations and contribution reductions for different filing statuses and income levels.

The "Backdoor" Roth IRA is a technique used to work around these income limitations rules for Roth IRA contributions.

So for those who earn enough money that they're not eligible to make a Roth IRA contribution, there's a "backdoor" way to still contribute money into a Roth IRA.

Here's the step-by-step process for this technique:

1. Contribute to a non-deductible Traditional IRA (essentially contributing to a Traditional IRA, and then characterizing the contribution on your tax return as non-deductible, using Form 8606)
2. Convert the non-deductible IRA into a Roth IRA account (it's generally best to convert the whole non-deductible amount)
3. Taxes are only due on any amount that is converted that is above your basis (basis is affected by whether you previously had a Traditional IRA account, per the examples below)

Below are examples of Backdoor techniques in two different scenarios.

Example #1: Conversion with NO pre-existing Traditional IRA Accounts:

• John has no Traditional IRA Accounts
• John contributes his maximum eligible amount of $6,000 to a Traditional IRA account, and is sure to characterize that contribution on his tax return as non-deductible, using Form 8606
• John later converts all funds from this account into a Roth IRA (now valued at $6,013 due to stock value increase)
• Taxes are only due on $13, since that is the conversion amount above his $6,000 basis (non-deductible contribution amount). This $13 is essentially the earnings on the account between the time John contributed his non-deductible IRA funds, to the time he converted them to a Roth.

Example #2: Conversion WITH pre-existing Traditional IRA Accounts:

• John has $60,000 in pre-existing Traditional IRA Accounts
• John contributes his maximum eligible amount of $6,000 to a Traditional IRA account, and is sure to characterize that contribution on his tax return as non-deductible, using Form 8606
• John later converts $6,000 from this account into a Roth IRA (now valued at $66,013...$60,000 initial value + $6,000 contribution + $13 earnings since contribution)
• Since only 8.4% of the account is from non-deductible contributions, only 8.4% of the conversion goes as non-taxable, as this 8.4% is the basis referenced in #3 in the above step-by-step process listing. So taxes are due on $5,083...since $462 is the prorated portion of the conversion that is non-taxable (equals the 8.4% basis)

So you can see that this technique is much more beneficial when conducted by those who don't have existing Traditional IRA accounts in place, as the taxability of the conversion to the Roth account is calculated using a prorated percentage of non-deductible vs deductible IRA funds.

However, there's also a way around this existing IRA limitation, which we'll illuminate in our next E-Newsletter...stay tuned!!

Also, remember that the total of all 2019 Roth & Traditional IRA Contributions cannot exceed $6,000 ($7,000 if age 50 or older), and must be less than your taxable compensation for the year.

Contact us if you have any questions on how this "Backdoor" technique can be used for you!