Roth IRAs are funded with post-tax dollars and grow tax-free! You can trade as much as you want inside of the account and even transfer to other IRA custodians without any penalties or taxable events.
Number 3 on that list is where, in the past, high-income earners have been out of luck when it comes to participating in the incredible TAX-FREE benefits of a Roth IRA. However, that all changed in 2010 when the income limit was permanently removed from Roth IRA conversions. What’s a Roth conversion, you ask? That is where you convert a Traditional IRA or any other pre-tax account into a Roth IRA. That type of conversion does create a one-time taxable event, which adds the amount being converted to your income for that year. The benefit of doing this is that going forward you have tax-free growth in a Roth IRA instead of tax-deferred growth in a Traditional IRA. This may or may not be the right move for everyone. As always, it’s best to consult with a tax professional who is familiar with your situation.
Now that you have an understanding of the 2010 conversion law let’s get into the nuts and bolts of how a Backdoor Roth works. For those who earn above the Roth income limit to contribute directly into a Roth IRA, the process works like this.
For most people, it is that easy! However, there are some additional things you need to be aware of to ensure you don’t have any further tax issues from setting up this type of account.
You or your spouse, if you file jointly, cannot have any other pre-tax IRAs. If you do, there is a pro-rata tax calculation that is assessed across the values of all your IRAs. I can go into the details of this, but instead, if you’re in this position, it’s definitely time to consult your tax advisor.
A Roth IRA is a great way to save and grow your wealth tax-free! And now, just about everyone can participate in this incredible program. So for all you high earners, pick your jaws up off the ground and get your Backdoor Roth IRA started. Remember, if you haven’t made a 2019 contribution, you can still make it until April 15, 2020. That means you can double up and contribute for 2019 and 2020. Either a maximum of $12,000 or $14,000 depending on your age.
Disclosure: I am not a licensed financial or tax advisor — consult with a tax professional to determine what is best for you.