Last updated: 1/26/2019
Do you like tax-free growth? Think you can't make a Roth IRA contribution because your income is too high? Well, think again.
What's the problem? If you make a lot of money, you likely can NOT make a contribution directly into your Roth IRA. Also, if you make a lot of money AND contribute to a retirement plan at work, you likely can NOT make a deductible contribution to your Traditional IRA.
What are the income limits for direct Roth IRA contributions? It depends on your tax filing status. Here’s an IRS link that shows the income limits: Roth IRA Income Limits IRS Link (Click here). Whatever you do, do NOT contribute directly to a Roth IRA if your income exceeds the limits as the penalty can be quite severe.
So what can you do? You can likely utilize what's known as the Backdoor Roth IRA Strategy.
What is the Backdoor Roth IRA Strategy? This involves making a NON-deductible (after-tax) contribution to a Traditional IRA (no income limits on this), then moving (converting) this contribution into your respective Roth IRA. This is called an IRA conversion. Because there are no income restrictions on an IRA conversion, this allows you to move (convert) money from your Traditional IRA into your Roth IRA, regardless of your income. The end result, you just used the Backdoor Roth IRA Strategy to get money into your tax-free Roth IRA.
Will you owe taxes on this conversion? Normally when you make a contribution to a Traditional IRA, it is a deductible contribution…it’s pre-tax and you get a deduction going in. So if you moved (converted) this type of Traditional IRA contribution (deductible/pre-tax) into your Roth IRA, you would owe taxes on the IRA conversion. But in the case of the Backdoor Roth IRA Strategy, you are actually making a NON-deductible contribution to your Traditional IRA. Since the contribution is NON-deductible (made on an after-tax basis), you’ve already paid taxes on this money. So if you ONLY convert your NON-deductible contribution (with no earnings or growth) AND you have no other money in IRA accounts (excluding Roth IRAs), you will not owe taxes on this conversion.
Think this isn't important? Consider this. If you use the above strategy to get $6000 (the 2019 max) into your Roth IRA every year for the next 20 years and your contributions grow at 8% per year over that 20 year period, you will have approx $296,000 in your tax-free Roth IRA account in 20 years. If you and your spouse both utilize this strategy, you would have a combined amount of almost $600,000 in potentially tax-free accounts (assuming the above numbers). Unless you'd rather have $600,000 in a taxable account, that's pretty cool.
But be careful! If you have other IRA accounts (Traditional IRAs, SEP IRAs, or Simple IRAs), there are a few more things you need to consider before doing the Backdoor Roth IRA Strategy. Frankly, it might not work. Don't take this lightly. FYI, don’t worry if you have money in a 401k, 403b, 457 plan, or profit sharing plan, this will have no impact on the Backdoor Roth IRA Strategy. Always consult your financial advisor and/or tax advisor before doing the Backdoor Roth IRA Strategy to make sure you are doing everything right.
Why don’t more financial advisors use the Backdoor Roth IRA Strategy? I’m not sure. You might have other IRA accounts (as noted above) that make this strategy less suitable. Or maybe they aren’t aware of this strategy. Or it’s possible they don’t want to take the time and effort to process the contributions and subsequent conversions as it offers little to no additional compensation for them (quite simply, they might be lazy).
HyLine Bottom Line: The Backdoor Roth IRA Strategy may allow you to accumulate a significant amount of money in a tax-free Roth IRA, regardless of your income. Unless you like paying taxes, that's a good thing.
What can I do at HyLine Wealth to help you with the Backdoor Roth IRA Strategy? If you think you would benefit from using the Backdoor Roth IRA Strategy, I can help you. First, I will inquire about any other IRA accounts you have so I can assess the situation and suitability (this is very important). Then, I will help you create the proper IRA accounts and keep the paperwork on file to process ongoing IRA conversions. I also recommend you link your IRA account to your checking/savings account so all you have to do is tell me when you are ready to make your contribution(s). After everything is set up the first time, it will be a breeze. And I will consult with your tax advisor when necessary to confirm any information. Bottom line, I will make this very easy for you.
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Questions? Don’t hesitate to reach out. If you have questions on anything, feel free to email me at firstname.lastname@example.org or call me at (605) 275-2343.
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5809 S Remington Place, Suite 101
Sioux Falls, SD 57108
Office (605) 275-2343
Location-Independent: Pretty much wherever you are located, we can work together. I am registered in the state of South Dakota and have an office in Sioux Falls. The “de minimis exemption” allows me to do business in most other states (with only a few exceptions). I consider myself "location-independent" as I use a heavy dose of technology to communicate and serve you. This includes screen sharing technology, electronic signatures when possible, and shared client portals so we can view the same information at the same time. Frankly, I can probably offer you better service than your "local" financial advisor.
HyLine Wealth is an investment adviser registered in the State of South Dakota. We do not provide tax or legal advice. Past performance is no guarantee of future results. Always consult your financial advisor, tax advisor, attorney, and/or insurance agent before implementing any specific strategy to make sure it is right for you and your unique situation. We are not responsible for the accuracy or upkeep of information on the links we provide to outside websites. If/when we provide a link to an outside website, be sure to independently confirm the accuracy of any information.