Backdoor Roth can be a tool, but a tricky oneSubmitted by Prosperity Advisory Group on December 15th, 2018
by Joel Morrison
A Roth IRA is a powerful savings vehicle which allows the money you put into it to grow tax free until you need it, presumably in retirement. Some people who would like to take advantage of it make too much money to do a normal contribution. I know, 1st world problems, right? That and the cost of jet fuel for my private plane are really starting to damage my calm.
Anyway, assuming you are in this boat, and you really want to get some money into a Roth and growing, the main stumbling block is whether you have some IRAs out there. This flowchart is fairly easy to walk through to see if this is an option for you. By the way, MAGI is modified adjusted gross income, a number you get from your tax return by adding up lines 37 and 8b of the 1040 form. Whew, if you’re still reading after that sentence, I salute you.
But if you get to the box that discusses figuring out how much of the contribution will be taxed, this is where having lots of IRAs might make you re-think the backdoor Roth strategy. Here’s an example:
Johnny has $95,000 in his IRA, all made of normal pre-tax contributions. He decides to try the backdoor strategy and makes a $5,000 non-deductible contribution to an IRA, as the first step. He then does a $5,000 conversion of those funds to the Roth, but here’s the thing: he has to pay ordinary income taxes on 95% of that $5,000. Because at the time of conversation he had $100,000 in IRA assets, 95% of which were traditional pre-tax and 5% were after-tax. If he had no IRAs, then his tax bill would be zero.
In the terms of the pros and cons of doing a backdoor Roth, there are too many variables to sum up here, which is why you should consult a CERTIFIED FINANCIAL PLANNER™, and a tax professional to boot. And I have to capitalize that designation, I’m not yelling at you, though I am proud to have earned it!
*For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisors LLC nor any of its representatives may give legal or tax advice.