Potential Death of the beloved Backdoor Roth IRA
November 13, 2016
It seems that Washington is looking for ways to shut down financial planning techniques that are commonly referred to as loopholes. The popularity of the backdoor Roth IRA and the double backdoor Roth IRA have exploded since a 2010 tax law change eliminated the income cap on Roth IRA conversions. Since this is a hot topic in Congress right now and may not be around much longer, we want to educate our clients so you can understand what double backdoor and backdoor Roth IRAs mean and how they can apply to you.
Many of our clients contribute to their non-deductible Traditional IRA annually to maximize their retirement savings, but they must pay tax on the earnings when they retire so it isn’t ideal, but it used to be their only option outside of an employer sponsored plan. They would love to contribute to their Roth IRA but they make too much money and are not allowed to contribute to the Roth IRA. The backdoor Roth IRA is a way for taxpayers to get around income caps that prevent them from contributing directly to their Roth IRA.
In 2010, the income limit on Roth IRA conversions was eliminated allowing any taxpayer to convert Traditional IRA money to Roth IRA money. The Roth IRA has many long-term financial benefits compared to the Traditional IRA so it should be no surprise that millions of taxpayers began converting money already in their Traditional IRA to a Roth IRA. They paid regular income tax on the conversion because distributions from Traditional IRAs are generally taxable upon withdrawal, but there were no penalties on conversion and all future growth is tax free. The double backdoor Roth conversion eliminates the tax impact of converting from Traditional to Roth.
If you participate in a non-IRA type of retirement plan (like an employer sponsored 401k) and that plan allows for rollovers from Traditional IRAs into the plan, then you are a candidate for the double backdoor Roth IRA. The double backdoor Roth IRA is done initially to empty the Traditional IRA account. The goal of the double backdoor Roth IRA is to first move all of your Traditional IRA money for which you have no non-deductible basis into the non-IRA retirement plan and then to second do a tax-free conversion for any remaining non-deductible Traditional IRA money to a Roth IRA.
After the initial double backdoor Roth IRA, you are free to do the backdoor Roth IRA annually so you can continue contributing to your Roth IRA. To accomplish the backdoor Roth IRA annually you need to (1) make a non-deductible Traditional IRA contribution and then (2) wait a week or so and convert the amount in your Traditional IRA to a Roth IRA. No tax is paid because you converted non-deductible IRA money so you have basis.
This is a very complex plan so consulting with d.a.g.i. and your financial advisor is necessary before you begin a double backdoor or backdoor Roth IRA.