The Front and Back Door for Roth IRAs
The Roth IRA was established by the Taxpayer Relief Act of 1997 and is named for its chief legislative sponsor, Senator William Roth of Delaware. Since 1997, the popularity of Roth accounts has exploded because of the tax advantages. The Roth IRA does not give you a tax deduction when you put contributions into the account, however the account allows your money to grow tax-free for life. That is very powerful, but putting money into a Roth IRA can be tricky depending on your income situation.
In 2019, the Roth IRA contribution limit is $6,000 per person or $7,000 if you are over 50 years of age. A Roth IRA does have income limits which is where the front and back door come into play. If you make under the modified AGI limit of $203,000 for joint filers or $137,000 for single filers in 2019, you can use the front door. Just put the money directly into your Roth IRA each year. You have until April 15, 2020 to make your 2019 contributions.
If you make over the income limits, you can still put money into your Roth IRAs, but you will have to use the backdoor. The backdoor lets you put money into a Roth IRA with an extra administrative step.
- Put money in a traditional IRA Since you are over the income limits the contribution will be considered non-deductible for taxes.
- Convert the account to a Roth IRA. This will move the money from your traditional IRA to your Roth IRA.
- Make sure your tax preparer reports the transactions properly on your tax return. It is best if you work with a CPA when doing this.
There are a few rules Roth IRAs must follow. The most important rule to understand for this strategy is the IRS pro-rata rule. To avoid complications, make sure you do not have any other traditional, SIMPLE, or SEP IRAs accounts with balances. If you do, the IRS will make you pay taxes on the percentage of pre-tax money you have in the other open accounts when you do the Roth conversion in step number two.
The pro-rata rule is one of the reasons we recommend you discuss this with a financial planner before doing it. If you do have other IRA accounts with balances, there are strategies you can consider that will consolidate the accounts and allow you to use the backdoor Roth IRA option. However, for some people, the extra complexity may not make sense.
We help our clients navigate the backdoor Roth strategy every year. It is amazing to watch couples use this strategy. Using a 6% average return, a couple over 50 can save almost $200,000 in Roth IRAs over 10 years. We find that couples in retirement with Roth accounts have increased flexibility with the withdrawal strategy which helps minimize taxes in retirement. Not to mention, Roth IRA accounts are great for legacy planning.
If you have questions, our advisors would be happy to talk with you. Please call us at (706) 364-4281.