What Is a Backdoor Roth IRA?
A Backdoor Roth IRA is possible if you make too much money, but it's an idea you can still take advantage of.
How does that work?
Well, you could not make any money at all, and you could contribute all the money to your traditional IRA outside of your employer.
But, there are people making too much money to contribute to a traditional IRA, and still they want to contribute to their retirement account. There are lots of ways to do that.
This post is going to specifically get into "The Backdoor Roth IRA" which has the tax benefits of a traditional IRA, but the tax benefits of a Roth IRA. Sounds like a pretty good deal for high-earners, huh?
So, let's get into this useful strategy.
Backdoor IRA Complication
We’ll Discuss the Roth IRA Contribution limit.
Workaround Of Existing IRA Accounts
What About a Roth 401(k)?
A Roth 401(k) is identical in all ways to a traditional Roth IRA. Both are available to individuals who are over the age of 18 and who can have earned income. In theory, you are limited to one of them. If you opt to participate in one, you cannot participate has a Roth IRA. However, if you have a 401(k) retirement account you can have a Roth IRA.
Whether you should choose the Roth 401(k) or the Roth IRA will depend on your circumstances. If you are set to get a large sum of money from a traditional IRA, you might not find the Roth 401(k) to be all that much better. Just because the money grows tax-free doesn’t mean that the amount of money you actually have to spend at retirement will be all that much better in a Roth 401(k) than in a traditional one. After all, all of the money in either of these accounts will be taxable when you retire and start to draw on it.
On the other hand, if you do your retirement accounting properly and take taxes into account, you might discover that the Roth 401(k) is a better option. In either case, you should discuss this with a professional to see what will work best in your circumstance.
Summary
The traditional way to make a retirement contribution to a Roth IRA is that you make a contribution with money that you didn't get a deduction on, because it is earned income that you don't fall in the allowable range for. The intent is that after you pay taxes on the money, you are hoping that you will have a lower tax rate in retirement than you do now. With the backdoor method, you contribute with money that you did get a deduction on, but you claim it was erroneous because you should have been reporting it as income.
You can report it as an interfund transfer or as a recharacterization.
Recharacterization might be the easiest because you can just do an online contribution and change the designation of the contribution to be a Roth IRA contribution instead of a traditional IRA contribution.
The best time to do it is at the beginning of the year.
Once you have your personal and individual contribution limit set up, then you need to decide if the backdoor method is for you. It is very much like purchasing a house, because part of the money you are contributing is really your own, but it is considered a general asset and you can borrow against it. If you don't contribute for 12 months, if you don't have the Roth contributions in one year, you have to start over again.