Roth IRAs : Front Door, Backdoor or No Door?

As the spring weather arrives and taxes are filed (or extended), now is a good time to consider your retirement plan. Be assured that there is “no one-size-fits-all” plan. Retirement planning can be quite complex, and it is important to understand the various retirement savings options available.

This blog will focus on one of the most popular accounts available: The Roth IRA. This account was named after the late Delaware Senator William Roth and became available in 1998. What makes the Roth IRA powerful and unique is the ability to see your retirement nest egg grow tax-free rather than tax-deferred.

Where to Start – The Front Door

So where do you begin? You must first see if you qualify to contribute directly to a Roth IRA (i.e. “Front door). The current requirements are:

  1. Must have earned income, whether W-2 wages or self-employment income.
  2. Must not exceed the income limitations. For 2022, the single taxpayer phase-out begins at $129,000 modified adjusted gross income and phases out completely at $144,000. For married filing jointly, the income phaseout begins at $204,000 and phases out completely at $214,000.

For 2022, the maximum contribution amount is $6,000 if under age 50. If you are age 50 or older, you are eligible for a $1,000 catch-up contribution which increases the total limit to $7,000.

Planning Tip: Keep in mind that working and non-working spouses may also be eligible to contribute. Therefore, a married couple could potentially contribute up to $12,000 or $14,000 if age 50 and older.

If you meet the eligibility requirements, the process to contribute is fairly simple. But what if you exceed the income limitation to contribute? Perhaps you can enter through the backdoor.

Another Entry – The Backdoor Roth IRA

The backdoor Roth IRA planning strategy became popular in 2010 when the income limitations to do Roth IRA conversions went away. This change in tax law opened the door for higher income taxpayers to redirect funds from a Traditional IRA into a Roth IRA.

Here’s a summary of how the backdoor Roth IRA works:

  1. Contribute to a Traditional IRA but treat contributions as non-deductible.
  2. Immediately (or sometime prior to year-end), convert non-deductible Traditional IRA dollars to a Roth IRA. The funds now grow tax-free as long as withdrawal provisions are met and minimal, if any, taxes are paid as a result of the Roth IRA conversion.

Caution: If you have other pre-tax Traditional/Rollover IRA dollars, this strategy does not work as well. All Traditional, SIMPLE, and SEP IRA dollars are factored into the calculation. Therefore, even if you convert the non-deductible IRA to a Roth IRA, you may pay taxes on the conversion once other pre-tax IRAs are factored into the equation.

Given the complexities, we strongly recommend you work alongside your tax advisor and financial planner to ensure that the transactions are reported appropriately.

Changes Could Come – No Door

We are well aware that there was a bill in Congress last fall to eliminate the backdoor Roth IRA strategy for higher-income taxpayers. The bill ultimately failed but exposed that this strategy is under scrutiny and may show up again in future bills in Congress.

That said, now is a great time to work alongside your financial planner and see if any of these strategies could make sense.

Be aware that most 401k plans now have a Roth 401k option. The good news: There are no income limitations and the contribution limits are higher than Roth IRA ($20,500 if under age 50 plus a $6,500 catch-up contribution if over age 50). The bad news: Your investment flexibility is limited to the plan options and accessibility of funds is more difficult.

In Closing

“The best time to plant a tree was 20 years ago. The second best time is now.’ – Chinese Proverb

This quote could be applied to retirement planning as well. Today is a great day to get started. Please don’t hesitate to reach out to us if you need a partner in planning.

*For financial planning clients of Rivertree Financial Planning: Please contact us as soon as possible if you have had any changes in circumstances, objectives, goals or risk tolerance.

Posted in ,