Today’s topic for Tax Tip Friday is Backdoor Roth IRAs. While Roth IRAs are very popular, many high income taxpayers are unable to contribute due to Modified Adjusted Gross Income (MAGI) limits. The backdoor Roth IRA is a strategy that allows high income taxpayers, who are unable to contribute to a Roth IRA due to MAGI limits, to indirectly make a Roth conversion. In 2024, the MAGI limits are $240,000 for married filing jointly taxpayers ($161,000 for single taxpayers). If done correctly, it can be a tax-free transaction.
The steps for a Backdoor Roth IRA are as follows:
- Taxpayer contributes money to a traditional IRA (assuming they are eligible to make a non-deductible traditional IRA contribution).
- Taxpayer immediately rolls over the traditional IRA contribution into a Roth IRA to avoid earnings on the contribution.
Be careful of the pro rata rule!
To the extent you have pre-existing IRA accounts funded with pre-tax dollars, the amount of the Rollover to a Roth IRA will be allocated proportionally between the deductible and non-deductible IRA contributions, creating taxable income. The portion of the Rollover attributable to pre-tax contributions will be considered taxable income.
One final consideration should be the five-year rule. Since the Backdoor Roth IRA is considered a conversion, not a contribution, you must wait five years to withdraw funds tax free. There are some exceptions to this rule.
Your investment advisor is most likely familiar with this strategy.
For additional information, please contact your tax partner/manager.
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