Roth IRAs are a robust way to save for retirement. You pay taxes up front on a Roth IRA — but after enrollment, all growth and withdrawals are tax-free.
For those with higher income levels, traditional IRAs are usually the favored investment because Roth IRA contributions have an income cap.
In 2019, if your modified adjusted gross income (MAGI) is $137,000 (single) or $203,000 (married filing jointly or qualifying widow[er]), you may not contribute to a Roth IRA.
So how can you utilize a Roth IRA if you’re in a higher income bracket?
What is a backdoor Roth conversion?
There is a backdoor method to opening a Roth. You can open a traditional IRA, and then roll the money into a Roth (once per year).
Anyone can convert money from a traditional IRA to a Roth IRA, no matter your earned income level. You can also roll an unlimited sum from an existing traditional IRA into a Roth IRA.
We aren’t trying to trick the IRS — this conversion is legal. You must still pay taxes on any money in your traditional IRA that hasn’t already been taxed.
What are the concerns with this strategy?
There are a few implications to be aware of if you’re considering a backdoor Roth conversion.
- You must have earned income. This includes wages, or self-employment income to be able to make a non-deductible IRA contribution.
- If you’re under 59½, you’ll have to wait 5 years for penalty-free access to your funds.
- The conversion triggers income tax on the appreciation of the after-tax contributions. Make sure you’re working closely with your accountant or tax advisor to properly calculate the tax owed.