5 Essential Backdoor Roth IRA Facts That You Need to Know

While most people can contribute directly to a Roth IRA, the IRS defines income limits that prevent high income earners from doing just that. Enter the backdoor Roth IRA—a colloquial term for the conversion of a traditional IRA to a Roth IRA which allows high income earners to indirectly fund a Roth individual retirement account.

We all know the awesome benefits of a Roth IRA:  money grows tax free and you pay no taxes on it in retirement. It’s no wonder that high income earners are willing to jump through a few hoops to access Roth IRAs. A backdoor Roth IRA essentially allows people with high incomes to avoid Roth IRA contribution limits.

Here is a list of 5 essential backdoor Roth IRA facts that you should know about.

1. A Backdoor Roth IRA is Essentially a Rollover of a Traditional IRA

Simply put, a backdoor Roth IRA is the act of rolling over a traditional IRA to a Roth IRA. While just about anyone with a traditional IRA can execute a backdoor Roth IRA conversion, it makes the most sense for high income earners. You see, the IRS establishes Roth IRA contribution limits based on your salary. Those who make over a certain salary are not eligible to contribute directly to a Roth IRA; however, they can fund a Roth IRA using this backdoor method.

2. Roth IRA Contribution Limits Dictate The Need for a Backdoor Roth IRA

Tax Filing StatusIncome (Modified AGI)Roth IRA Limit
Married filing jointlyLess than $193,000$6,000
$193,000 to $203,000Reduced amount*
$203,000 or more$0
Married filing separately
living with your spouse
Less than $10,000Reduced amount*
$10,000 or more$0
Single, head of household, or
married filing separately

not living with your spouse
Less than $122,000$6,000
$122,000 to $137,000Reduced amount*
$137,000 or more$0

*use IRS Worksheet 2-2 to determine your reduced Roth IRA contribution limit

Not everyone needs to fund their Roth IRA through the backdoor method. A backdoor Roth IRA is only necessary for high income earners according to the 2019 Roth IRA Contribution Limits table above. Anyone who has a Roth IRA contribution limit of $0 or a reduced amount can fund a Roth IRA via the backdoor method.

3. Immediately Rollover a Traditional IRA to Roth IRA to Avoid Taxes

In order to minimize taxes, it is recommended that you convert your traditional IRA to a Roth IRA as soon as possible after contributing. Whether you make periodic deposits into a traditional IRA throughout the year or one large lump sum contribution, the sooner you rollover from traditional to Roth, the better.

You must pay tax on any traditional IRA earnings when converting to a Roth IRA. Therefore, it makes sense to fund your Roth IRA through the backdoor method immediately after contributing to your traditional IRA. In other words, rollover your traditional IRA funds to a Roth IRA account right after making any contributions.

The one-rollover-per-year rule does not apply to rollovers from traditional IRAs to Roth IRAs meaning you can technically fund your backdoor Roth IRA multiple times per year. Although you have this freedom and flexibility, be sure to convert from traditional to Roth as soon as possible after funding your traditional IRA to avoid paying taxes on any gains.

4. You Have Until April 15, 2020 to Make a 2019 IRA Contribution

Contrary to popular belief, the IRA contribution deadline is April 15th of every year, not December 31st. This means you can make 2019 IRA contributions until April 15, 2020. In other words, you have a total of 15.5 months between January 1, 2019 and April 15, 2020 to contribute to your IRA accounts.

Because there is an extra step of rolling over funds and since you want to avoid paying taxes on gains, it is recommend that you fund your traditional IRA in a lump sum sometime before the April tax deadline and quickly convert theses funds into a Roth IRA via the backdoor method.

5. You Must Have Earned Income to Fund a Backdoor Roth IRA

If you don’t earn any income during the year, you are not eligible to contribute to an IRA. Earned income does not include:

  • Rental income
  • Dividend or interest income
  • Annuity or pension income
  • Unemployment income
  • Social Security payments

Additionally, if your income is less than the Roth IRA contribution limit, you can only contribute as much as you earn. For example, the Roth IRA contribution limit in 2019 is $6,000. If you only earn $3,500 in 2019, you can contribute at most $3,500 to an IRA.

Although I don’t earn enough money (yet) to need a backdoor Roth IRA, I am still very much interested in this topic and the topic of retirement savings and investing in general. Do you have a backdoor Roth IRA or planning on contributing to one? I’d love to hear from you in the comments below.

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