what is a backdoor ira -- Asian woman opening a blue door and smiling

What Is a Backdoor IRA?

Individual Retirement Accounts (IRAs) offer an excellent opportunity for people to save money in preparation for retirement. However, people who make more than a certain amount of money cannot contribute to a Roth IRA. But what if there was a way to contribute to a Roth IRA even if you make more money than is normally allowed? A backdoor Roth IRA can be used in that type of situation. 

Why would you want a backdoor IRA?

There are two main types of IRAs —traditional and Roth. Both types of IRAs  come with their own rules and stipulations. 

A traditional IRA allows you to save part of your pre-tax income. You don’t have to pay any taxes on that saved income until you begin withdrawing funds at age 59.5. With a Roth IRA, contributions are taxed when they are placed into the savings account. That means you can withdraw funds from a Roth IRA at any age, without having to pay taxes. 

Although anyone at any income level can open a traditional IRA, there is an income limit for opening a Roth IRA. A single-income tax filer can open a Roth IRA if they make $140,000 or less in 2022. And a married couple filing income tax jointly needs to make $214,000 or less in 2022 for Roth IRA eligibility. 

While some people may not mind having to pay taxes on money they withdraw from a traditional IRA, a Roth IRA may be more enticing to others. This is where a backdoor IRA comes into play. 

How to Do a Backdoor Roth IRA Conversion

Step 1: Set Up a Traditional IRA Account

While it may sound counterintuitive, to use the backdoor Roth IRA method, you need to set up a traditional IRA account first. Or, if you already have a traditional IRA, you’ll need to make a contribution to it if you haven’t done so already. 

Step 2: Convert to a Roth IRA

Work with an investment advisor to fill out the necessary paperwork for converting your traditional IRA to a Roth IRA. This will open up a Roth IRA for you.  

Step 3: Pay Your Taxes

Although you will ultimately have the Roth IRA with all its benefits, you will still need to pay income tax on any money converted from a traditional IRA to a Roth IRA through the backdoor method. Additionally, you may have some other taxes to pay as well. Your investment advisor can walk you through the process and calculate how much you may have to pay in taxes for the conversion. 

Preparing for Retirement in Arizona

It is important to note the U.S. House of Representatives is currently considering a new bill that may change how the backdoor Roth IRA conversion works, and could possibly eliminate it altogether. If you are thinking of using the backdoor Roth IRA method, you may want to act quickly, just in case laws prohibit it later this year. 

If you decide to open an IRA account, don’t forget to make sure to list it as an asset in your estate plan. You can also help protect the money in your IRA by setting up an IRA trust to ensure your primary beneficiary receives your hard-earned funds when you pass.

If it’s time for you to update your estate plan or to set up an IRA trust, Phelps LaClair is ready to assist! Call us at 480-892-2488 to make an appointment at one of our many convenient locations across Arizona.

Photo by Ketut Subiyanto on Pexels.com

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