Instead of an official category of individual retirement account, a backdoor Roth IRA is more of a financial plan. High earners with an annual income exceeding the Roth IRA income limit may convert their regular IRA into a Roth IRA by using this strategy.
There is no way to get around paying taxes by using the backdoor Roth IRA technique. Suppose you convert the assets in your conventional IRA to those of a Roth IRA. In that case, you will be responsible for paying taxes on any money, including the principle, earnings, and appreciation, that were not subject to taxation in the past.
If the IRA were only ever funded with contributions eligible for a tax deduction, the entire value of the transferred assets would be subject to taxation. However, as with any Roth IRA, if you follow the rules, you should not owe any additional taxes when you withdraw the money.
Taxpayers can put away a few thousand dollars from each year's earnings in an account designated specifically for retirement savings via a Roth IRA. The donated money has already been taxed, which means that it comes from earnings that were already taxed in the year that they were contributed to the Roth IRA.
A traditional IRA is not the same thing as a Roth IRA. Because the contributor may claim a tax credit for their contributions in the same year they are made, and no taxes are required to be paid on the money until it is withdrawn, the conventional IRA provides the recipient with immediate tax savings. When the account holder makes withdrawals, which often occurs after retirement, they will be responsible for paying taxes on the amounts they initially invested and the gains they have accrued from those dollars.
The fact that persons who earn more than a specific amount are not permitted to open or fund Roth IRAs presents a challenge for taxpayers with high incomes. If your MAGI is higher than the statutory ceilings, then the law will begin reducing the amount you are allowed to contribute, which will be between $129,000 and $144,000 for single filers in 2022, between $204,000 and $214,000 for joint filers in the same year.
For single taxpayers, the range for 2023 is between $138,000 and $153,000, while the range for joint filers is between $218,000 and $228,000. You are no longer eligible to participate in the program if your annual income exceeds the stipulated level, now $214,000 for joint filers and $144,000 for single taxpayers.
There are no maximum income requirements to contribute to a traditional IRA. In addition, the Internal Revenue Service (IRS) has not restricted a person's ability to convert their conventional IRA into a Roth IRA based on their income since 2010. Consequently, the backdoor Roth IRA has developed into an avenue for tax planning for taxpayers with higher incomes who, under normal circumstances, would be unable to contribute to a Roth IRA.
You have three options when it comes to setting up a backdoor Roth IRA:
Why would taxpayers want to do the additional steps needed in executing the backdoor Roth IRA dance, other than it allows them to circumvent the limitations? There are several compelling arguments in favor of this.
Because Roth IRAs do not have required minimum distributions, often known as RMDs, account balance can grow tax-deferred for as long as the account holder is still living. You are free to withdraw as much or as little of the money as you choose anytime you wish; alternatively, you might leave it entirely to your heirs.
The withdrawals from a Roth IRA, in contrast to those from a regular IRA, are not subject to taxation, which is another reason why a backdoor Roth contribution may result in large tax savings over many decades.
