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Back Door Roth IRA

What is a Back Door Roth IRA? Is it even legal? It sounds shady.

These may be things you ask yourself or tell yourself about the back door Roth IRA. I will try to answer these basic questions, tell you who this is for, and point you in a direction to get even more and better advice on how/when to do this.

Most everyone knows what a Roth IRA is. A Roth IRA is different from a Traditional IRA in a couple of ways. With a Traditional IRA, you get a tax break up front. Meaning, whatever you contribute to a Traditional IRA for that year, you don’t have to pay taxes on it. However you do have to pay taxes on it when you withdraw it. You can withdraw it without penalty at 59 1/2 and must take required minimum distributions (RMD’s) when you are age 70 1/2. With a Roth IRA, you don’t get to take a tax deduction on the amount you contribute however when you withdraw you do not need to pay any taxes. You also don’t have to wait until you are 59 1/2 to withdraw. You can withdraw it any time (Although I recommend you don’t take it out until retirement). There are also no RMD’s for Roth’s.

There are also Roth options for some 401k’s. Meaning you don’t get the tax break up front, but you don’t pay taxes when you take it out. However, these still do have the age requirements to withdraw it without penalty. Most guru’s recommend you don’t do the Roth option in your peak earnings years if you are a high income professional as your tax bracket now is likely to be higher than in retirement. However if you are not a high income earner, the Roth option is a great option.

So what is a back door Roth IRA? Well, once you hit a certain income level ($124,000 if single, and $193,000 if married filing jointly) you are not eligible to fund a Roth IRA directly. A lot of people think that means they can’t fund a Roth IRA. That isn’t true. Most high income earners should make pre-tax contributions to their 401k and get the tax break upfront. But then instead of only having taxable accounts as an option to invest for retirement, you then can do a back door Roth IRA. As of 2019, you can contribute $6,000 for each spouse to a Back Door Roth IRA each year (more if you are over 50 years old). You don’t get a tax break up front, but when you withdraw it you won’t have to pay taxes. Then after that if you have any money to invest, a taxable account is just fine.

The front door to a Roth IRA may not be open to high income earners, but the Back door is open.

How do you fund a Roth IRA via the back door? Well, I will explain briefly but I will punt to my much wiser brethren in The White Coat Investor and The Physician on Fire.

First contribute after tax money to a traditional IRA (don’t take the tax deduction). Then the next day transfer that money from your Traditional IRA to your Roth. Thats about it. Except by Dec. 31st of the year you do this, you have to make sure you have no money in any Traditional, SIMPLE, or SEP IRA’s. If you have any money in any of these accounts, the Pro Rata rule will get you on taxes. Again, The White Coat investor explains this in detail as well as other ways to mess up a Back Door Roth. Don’t get discouraged about all the ways to mess it up. It really is very simple and totally legal.

What if you have money in a Traditional, SEP, or SIMPLE IRA. Well there are three options really. 1. Don’t do a Back Door Roth, 2. Just convert the whole thing to a Roth IRA paying taxes on the gains. I don’t recommend you do this if you are in a high tax bracket and have a lot of money in one of these types of IRA’s. 3. Roll over any Traditional, SIMPLE, or SEP IRA into a 401k you have. Then you have no money in these and you are free to do a Back Door Roth. 401k monies are not counted towards the Pro Rata calculation. Just make sure your 401k accepts rollovers from these accounts.

So there you have it. The Back Door Roth IRA. It is a great option for high income professionals who make too much money to contribute directly to a Roth. Please feel free to ask me any questions via the contact page or leave a comment.

-The Debt Free Dentist

*Nothing on my website is professional or legal advice. I am only sharing information that I have learned and it may or may not be accurate. I am not liable for any problems you may have by following this advice. Please do further research and get professional and/or legal advice about any of these topics.

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