The Back Door Roth IRA

Making Smart Decisions with Josh Tirado

You're listening to making smart decisions with Josh Tirado. Today's topic is the backdoor Roth IRA. In the last year to the backdoor Roth IRA, concept has gained popularity. If you Google it, you will find a number of articles online, explaining and detailing the backdoor Roth IRA. And also a lot of times it's.

[00:02:04] Heavily sprinkled with the author's opinion on the strategy. So I want to talk today about some of the rules concerning the backdoor Roth IRA, how you could utilize it. If it's something that is for you or not, and what you want to consider. First and foremost, let me say that consulting with your professional.

[00:02:23] When it comes to the tour Roth IRA, whether using a backdoor Roth IRA or doing some sort of Roth IRA conversion, you definitely have to speak with your professional because we have software. We can run multiple scenarios and compare and contrast and see if this is the right strategy for you. For some people, it's a home run. For some people, it should really be a no go.

[00:02:44] And there is a large amount of a gray area. But a lot of it's dependent upon your strategy. And what I don't like is a lot of the articles I'm finding online concerning the backdoor Roth IRA concept, as I said before, heavily influenced by the author's opinion and a lot of the opinions for or against the concept.

[00:03:02] Are based on some outlier factors and really what would not have applied to the majority of people out there, but what would apply to the minority. So they're looking more for the exception than the rule. the Roth IRA, there are some limitations to contribute to a Roth IRA.

[00:03:21] There is an income limitation.

[00:03:23]For instance, in 2019, if you are a single head of household person filing your taxes. If you make less than 122,000 modified adjusted gross income, you can contribute a maximum of $6,000 a year to Roth IRA. If you're age 50 or older, you can contribute $7,000. That's been adjusted in the year 2020. You have to make less than 124,000 modified adjusted gross income to maximize your contribution.

[00:03:53] Above 124,000 up to 139. The amount you can contribute is reduced and above 139,000. No contribution is allowed. If you are married and filing jointly, the number that you have to make is less than 196,000 from 196 to 206,000; your contributions are reduced a to 6 and above no contribution is allowed at all above that.

[00:04:16]Also, the contributions are available. You can make them up to the following year. So say you wanna make a 20, 20 contribution and you're now in 2021, cause you wanted to see how your income is going to look to see if you're going to be allowed to contribute or not. You can still make a 2020 contribution in the year 2021.

[00:04:32] It just simply has to be done earlier than April 15th or whenever your taxes are filed. And before that, you can make a contribution for the preceding year. Again. It's something to 6,000 a year or 7,000 a year for age 50 or older. And you do have to show that you made some income.

[00:04:49]also you can be, you can, there are different rules concerning the spouse, whether or not the spouse is working, the spouse can also potentially contribute. So what we're looking at here are people that would like to do a Roth IRA, but make, and I'm doing air quotes that are making too much money to be able to contribute to one.

[00:05:05] So this concept of a backdoor Roth IRA has become very popular. there are a few methods. The two most popular are if you're working and you're enrolled in a 401K plan, and your 401k offers a Roth 401k option, you can utilize that regardless of your income, you can contribute to the Roth portion of a 401k.

[00:05:25] And it's also not subject to the six or $7,000 limit. It's subject to the normal 401k contribution limits. So you can put even more money into it. That's pretty straightforward. The other concept is to contribute to a traditional IRA, the six or $7,000. And either you can do it right after you contribute, or you can wait and let it build-up, but you contribute to a regular IRA, traditional IRA, and then you do a conversion and convert the traditional IRA over to a Roth IRA.

[00:05:56] The conversion is not subject to your income. So if your income is above those thresholds, you can always convert a traditional line. At least the way the law stands. Currently, . you can convert a traditional IRA to a Roth IRA. Now the main difference here is traditional IRA is pretax money where your contributions tax-deductible, a Roth IRA is using after you've paid tax post-tax money.

[00:06:21] So there's no deduction. And if you make a contribution, there's no deduction. They will both grow tax-deferred, but in the end, everything you pull out of a traditional IRA will be considered ordinary income. And it'll be subject to taxes, normal income tax, a Roth IRA will grow tax-deferred, and then every single pull out of it, both principle and gain will be completely tax-free.

[00:06:45] So the trade-off is you don't get the tax break in the beginning, but in the end, everything you have in there is completely tax-free. Now there's a lot of speculation about what our tax is going to be in the future. If this is a good strategy or not, if you are receiving a lot of your income down the road and , if it's coming in the form of capital gains on other investments, that's currently taxed a lower rate than income.

[00:07:09] However, most people are relying on income and retirement coming from IRAs and other pretax sources. So it will be counted as taxable income. It is very nice to have options when you go to utilize your income in retirement. And when I say options, some money is pretax. So when you pull it out, it's taxable; some money has been contributed after tax.

[00:07:32] Maybe it just went to a brokerage account. Or where you went into a Roth IRA at that point, it gives you options. We can say, okay, somebody should come out of a traditional IRA where it's taxable. Some of that can come out of a Roth IRA or another investment where it's not taxable, and you can really have much more control or what your taxable income looks like in any given year in retirement.

[00:07:55] So I liked the idea of being able to access to a Roth IRA as well as a traditional IRA.

[00:08:01]I won't say it's a problem, but where a lot of these articles come in is they're suggesting that depending on the level of income you need or what tax bracket you're going to be in retirement, maybe doing a Roth or rough conversion is not a good idea, but a lot of these articles are addressing some in their forties or fifties.

[00:08:17] And it's hard to project when you retire, and you're in your sixties, seventies or eighties, and you're going out 20 or 30 years, what tax rates are going to look like, what tax bracket you're going to be in. So I'm very much of the opinion of it is great to have some pre-tax money and some after-tax money and straddle the fence, if you will.

[00:08:35] So no matter what the landscape looks like, you can adjust accordingly. So when it comes to a backdoor Roth, we really have to analyze the number of features going in. Where are you getting the money from? How are you going to pay the taxes on the Roth conversion? Do you want to give up the tax deductibility now, and will it really benefit you?

[00:08:54] Generally speaking, when I found clients is the longer that they're invested, the better, the Roth will work for them. And if they have an outside source to pay the taxes, do when they convert a traditional IRA to a...