The door was closing on the backdoor Roth IRA strategy as part of the Build Back Better Act. However, since the law stalled in the Senate, the door remains open for 2022.
A Reminder About Traditional IRAs vs. Roth IRAs
The money you contribute to your Roth IRA is after-tax dollars, meaning you will have already paid income tax on it before putting it into your account. In turn, that money continues to grow tax-free. Because you already paid taxes on that income before contributing it to your Roth IRA account, you do not have to pay taxes on it when you withdraw money in retirement. This, essentially, creates tax-free withdrawals in retirement.
If you choose to place your money in a traditional IRA account, you are using pre-tax dollars. This means the money has not been taxed, which can be an effective strategy in lowering your present taxable income. In return, the money in your traditional IRA account grows tax-deferred. Once you reach retirement and begin making withdrawals, you will be responsible for paying taxes on the withdrawals.
With both traditional and Roth IRA Accounts, there are restrictions and annual maximum contribution limits that may be adjusted annually by the IRS. Before contributing to your account, you’ll want to check these limits or ask your financial advisor to clarify.
Backdoor Roth IRA Explained
Roth IRA accounts have income limits. In 2022, you are ineligible to contribute to a Roth IRA account if you earn:1
- $144,000 or more as a single filer
- $214,000 or more as a joint filer
If you are a high earner with an income above the IRS’s income limit for Roth IRA accounts, you still have the option to create a backdoor Roth IRA. Just as it sounds, this option allows high earners to bypass the income limits and still utilize the tax advantages of a Roth IRA account.
Here’s how to create a backdoor Roth IRA account in a nutshell:
- Open and contribute to a traditional IRA.
- Convert your traditional IRA to a Roth IRA account (your account administrator will provide the necessary paperwork and instructions to do this).
- Once tax season rolls around, pay taxes on the contributions (essentially you’re paying back the tax deduction you received when initially contributing to your traditional IRA).
- Pay taxes on any additional gains your traditional IRA account may have made over time.
Although the Build Back Better act stalled in the Senate, there is always the potential congress will act to close the backdoor on the backdoor Roth IRA strategy. This suggests it might be better to act sooner on this strategy than later.
This content is developed from sources believed to be providing accurate information, and was adapted from content provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.