Creating a “Backdoor Roth IRA” for High-Income Earners

Why is Everyone so Into the Roth IRAs?

Some consider the Roth IRA to be an ideal investment vehicle for several important reasons:

• Tax-Free Growth and Withdrawals: Money invested in a Roth IRA not only grows tax-free, but withdrawals in retirement are also tax-free.
• No Required Minimum Distributions (RMDs): Unlike traditional IRAs or 401(k)s that require you to take money out of your account beginning at age 72, Roth IRAs do not require you to take minimum distributions…ever! This allows you to retain your Roth through your entire lifetime if you wish and even pass it on to your heirs tax-free.
• Tax Flexibility in Retirement: Because withdrawals from a Roth IRA are tax-free, they provide flexibility in managing your taxable income during retirement. This can help you stay in a lower tax bracket and potentially reduce taxes on Social Security benefits and Medicare premiums.

These features make Roth IRAs a versatile and powerful tool for retirement planning, offering significant tax advantages and flexibility.

So, what’s the catch?

If your income exceeds certain limits, you cannot contribute directly to a Roth IRA. For 2024, the income thresholds are $146,000 for single filers and $230,000 for married couples.

An Innovative Solution: The “Backdoor Roth IRA”

A Backdoor Roth IRA provides high-income earners a way to create and fund a Roth IRA, allowing them to enjoy its numerous benefits. This strategy involves making non-deductible contributions to a traditional IRA and then converting those funds to a Roth IRA. But you must carefully follow these steps:

Creating a Backdoor Roth IRA

• Contribute to a Traditional IRA:

• Open a traditional IRA account if you don’t already have one.
• Make a non-deductible contribution to the traditional IRA. For 2024, the contribution limit is $6,500, or $7,500 if you are 50 or older.

• Convert to a Roth IRA:

• Once the funds have settled in the account, convert the funds from the traditional IRA to a Roth IRA. This can usually be done through your financial institution’s online platform or by contacting them directly.
• Be aware that any earnings on the contributions before the conversion will be subject to taxes.

• File IRS Form 8606:

• When you file your taxes, complete IRS Form 8606 to report the non-deductible contribution and the conversion. This form ensures that you are not taxed twice on the same money.

Important Considerations

• Pro Rata Rule:

  If you have other traditional, SEP, or SIMPLE IRAs, the IRS requires that all your IRAs be considered together when calculating the taxable portion of your conversion. This is known as the pro rata rule and can complicate the tax implications of your conversion.

• Timing:

  Consider the timing of your conversion carefully. Converting when your traditional IRA has minimal earnings can reduce the tax impact.

• Consult a Professional:

  Given the complexities involved, it’s wise to consult with a financial advisor to ensure that a Backdoor Roth IRA is the right strategy for your situation and to help navigate the process.

A Backdoor Roth IRA can be a powerful tool for high-income earners to take advantage of the benefits of a Roth IRA. By following the steps we’ve outlined, you can effectively implement this strategy as part of your overall financial plan. Always consider consulting with a financial advisor to optimize your approach and avoid potential pitfalls.

When it comes to your wealth, you deserve a team of financial professionals you can trust to unite the complexities into a single, simple strategy. Connect with OneDigital’s Wealth Management team to learn more.

Investment advice offered through OneDigital Investment Advisors LLC, an SEC-registered investment adviser and wholly-owned subsidiary of OneDigital. These materials are provided for informational and educational purposes only and do not constitute a recommendation to buy, sell, or hold any security, nor do they constitute legal, accounting, investment, or tax advice. The materials and the information provided are not designed or intended to be applicable to any person’s individual circumstances. These statements do not constitute an offer or solicitation in any jurisdiction. All included information and data are limited only to the inputs and other financial assumptions indicated.