If you want to save for retirement and enjoy tax-free withdrawals, Roth IRAs are a great option. Unlike traditional IRAs, Roth IRAs do not tax the growth of your savings.

But there is a catch. You can only contribute to a Roth IRA if your income is below a certain limit. If you earn too much, you have to use a different strategy: the “backdoor” Roth IRA.

How does it work and is it right for you? It depends on your financial situation. Here is what you need to know.

Why a Roth IRA is Worth Your Time
A Roth IRA has several advantages over a traditional IRA, such as:

  • Tax-free withdrawals. You can withdraw your contributions and earnings from a Roth IRA without paying any taxes, as long as you follow the rules. This can save you a lot of money in retirement, especially if tax rates are higher in the future.
  • No required minimum distributions (RMDs). You do not have to take out any money from your Roth IRA at a certain age, unlike a traditional IRA. This gives you more flexibility and control over your retirement income.
  • Estate planning benefits. You can pass on your Roth IRA to your heirs without any taxes, as long as the account has been open for at least five years. This can be a valuable legacy for your loved ones.
  • Roth IRAs allow you access your contributions at any time before age 59.5 with no penalties (The growth on the principal is treated differently).

 2024 Roth IRA Income Limits
The income limits for Roth IRA contributions in 2024 are $161,000 for single filers, $240,000 for married couples filing jointly.

If you’re pulling in a six-figure income and happen to be a reader of this blog, chances are high that you’re maximizing your contributions to a Traditional 401(k). This implies you’re benefiting from a $23,000 deduction. That means to reach the point of complete phase-out, a single individual would likely need an income closer to $184,000, while a married couple might need around $286,000 to be phased out ($286,000 married minus $23,000 for each partner is $240,000 which is the upper Roth IRA contribution limit).

But what if your income is still beyond the Roth IRA income limits? That’s where the backdoor Roth IRA comes in.

How it Works
A backdoor Roth IRA is a way to get around the income limit for Roth IRA contributions. You use money that you have already paid taxes on, such as your regular income, to fund a traditional IRA. Then you convert it to a Roth IRA and enjoy the tax-free benefits.

You might wonder why you would bother with a traditional IRA if you can’t deduct your contributions. The reason is that you can switch IRAs from traditional to Roth, which is the main benefit to this strategy.

Here are the steps to follow:

  1. Open a Traditional IRA and Roth IRA if you don’t have one already.
  2. Make a non deductible contribution to your Traditional IRA ($7,000 max for 2024). Don’t invest the money yet, just keep it in cash.
  3. Wait for a few days until the money clears.
  4. Transfer the cash from your traditional IRA to your Roth IRA. You can do this online or by calling your broker. Since the money is not invested, there is no tax on the conversion.
  5. Invest the money in your Roth IRA.

And that’s it.

There is one thing to keep in mind, when you use the backdoor Roth IRA method, you have to wait five years before you can withdraw without penalty.

When Should You Not Consider this Strategy
A backdoor Roth IRA isn’t it for everyone. Obviously, if you are able to make a Roth IRA contribution the standard way then you don’t need to use the backdoor method.

You probably do not want to do a backdoor IRA contribution if you already have a balance in your IRA because of the pro-rata rule.  This rule requires that IRA distributions must be proportionally drawn from both pre-tax and after-tax dollars.

For instance, if you have a total of $100,000 in IRA assets, with $10,000 (10%) being after-tax funds, then 10% of any withdrawal must come from after-tax money. In a $10,000 withdrawal, only $1,000 will be tax free and you’ll be taxed on the remaining 90%.

For this reason I would only attempt this if you don’t have a large balance in a traditional IRA already.

If you need assistance with this strategy, our team at PMG Wealth Management is here to help. Please feel free to call or email us with any questions.

George Maroudas, CFP®

George Maroudas, CFP®

Twitter @ChicagoAdvisor


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

This information is not intended to be a substitute for specific individualized tax advice.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.

It’s essential to consult with a financial advisor or tax professional before implementing a Backdoor Roth IRA strategy, as individual circumstances can vary, and tax rules may change over time.

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