By Adam Smit

“Backdoor” ROTH IRAs Not everyone qualifies to make contributions into a ROTH IRA due to income limits. While not an official type of retirement account, the “Backdoor” ROTH IRA is effectively a method for some high-income earners to still get contributions into a ROTH IRA. The following article will outline the logistics and details related to funding a “Backdoor” ROTH IRA.

The “Backdoor” ROTH IRA is the informal name for a strategy used by high-income taxpayers who do not qualify to fund a ROTH IRA directly, by first making a non-deductible contribution to a Traditional IRA and then immediately converting those assets to a Roth IRA. Depending on modified adjusted gross income and tax filing status, high-income earners may not qualify to make contributions directly into their ROTH IRA. However, since 2010, there is no income limit for those converting existing IRA1 balances into a ROTH IRA. Additionally, there are no income limits for non-deductible (post-tax) Traditional IRA contributions.

Investors considering this strategy should be aware of the pro-rata rule in ROTH IRA conversions. This rule states that if you convert an IRA to a ROTH IRA, the amount of total outstanding pre-tax IRA balances is considered proportionally to be converted to the ROTH IRA. For example, an investor with $20,000 in pre-tax IRA balances and $5,000 in post-tax Traditional IRA balances, of the amount converted to the ROTH IRA, 80% of the conversion would be subject to taxation at the time of conversion ($20,000 pre-tax balance / $25,000 total balance = 80% of total being pre-tax). Effectively, the pro-rata rule makes the “Backdoor” ROTH strategy less attractive for those individuals with outstanding pretax IRA balances. Note, the pro-rata rule only looks at IRA balances, not 401k balances, which provides an additional planning strategy beyond the scope of this article. The “Backdoor” ROTH strategy should be executed with the clients tax advisor being part of the discussion and informed on this advanced planning strategy.

Besides the “Backdoor” ROTH contribution strategy, high income earners may consider funding their ROTH 401k (if available) as the ROTH 40 lk has no income limitations to participate.

The “Backdoor” ROTH funding strategy is an advanced financial planning strategy for high-income retirement investors. While this strategy is widely used and a generally accepted strategy, the 1RS still may disqualify transactions they deem as circumventing tax law. It is recommended to consult with a tax professional before proceeding with this

strategy.

Adam Smit is a CERTIFIED FINANCIAL PLANNER™. Tax preparation services are not offered at Adam Smit Investment Management LLC and customers should seek specific tax guidance from a qualified tax advisor. This article is for general information only and not intended to provide specific advice or recommendations. Securities offered through LPL Financial. Member FINRA/SIPC.

1 – The term “IRA ” in this case also refers to other pre-tax IRA types such as a SEP IRA and SIMPLE IRA