You may have heard of a Roth IRA, but you may have been disappointed to learn that they have certain limits, especially regarding your income. The IRA limits how much you can contribute to a Roth IRA if you make more than a certain amount.
But, belief or not, there are ways around some of these limits. How? Use the ‘Backdoor!’ If you want to know what that means, read this article until the end. I’ll show you that you can put money into a ‘Roth IRA’ no matter how much money you make through a method called a “Backdoor Roth IRA,” also known as a ‘Roth IRA’ conversion.
I’ll walk you through the process and answer any questions you might have. Let’s start learning!
What is a Roth IRA?
A Roth IRA is like a traditional Individual Retirement Account, but you put money into it that has already been taxed. It means you don’t get a tax break right away as a traditional IRA.
The best thing about a Roth IRA is that you don’t have to pay taxes when you take money out. You don’t have to take out a minimum amount from a Roth IRA, so you can let the money grow for longer. A ‘Backdoor Roth IRA,’ has the effect as if there were no income limits.
Even if you make $2 Million a year, you can still have a Roth IRA through this process. You first need a ‘Traditional Roth IRA.’
Suppose your modified adjusted gross income is more than $206,000 for a married couple filing jointly or $139,000 for a single person filing. In that case, you can’t make a traditional contribution to a Roth IRA.
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For ages Under 50, the contribution limit is $6,000 per year. But if you’re over 50, you can make a “Catch-Up” contribution and increase your limit to $7,000.
How Do You Set Up A Backdoor Roth IRA?
#1 Open A Traditional IRA
The first step is to ‘Open A Traditional IRA.’ You can do this at any brokerage account, such as Vanguard, Fidelity, or Charles Schwab. Select a traditional IRA as your account type, and set up a transfer to your limit of $6,000 or $7,000.
Look over your application and send it in. Make sure that this is a traditional IRA account and that you’ve put $6,000 or $7,000 into it. For some brokerages, you may have to wait anywhere from two business days to four weeks for the money to settle into your traditional IRA account.
So, after a few business days, when the money has settled into your traditional IRA, you are ready for the next step: turning your traditional IRA into a Roth IRA.
#2 Turning Your Traditional IRA Into A Roth IRA
One thing to keep in mind is that you should do this step as soon as you can, which means as soon as that money has settled into your traditional IRA. You don’t want the money in your traditional IRA to grow or have any time to grow.
In this step, you’ll go to your traditional IRA and click the “Convert To Roth IRA” button. When you click that button, the website will take you to a page with a big yellow sign saying you are responsible for any due taxes.
You don’t have to worry about this because the first money you put into your IRA wasn’t tax deductible. So you can skip this section. Check everything twice, and when you’re done, click “Submit.” You have just converted your traditional IRA into a Roth IRA.
It might seem sketchy, but believe it or not, it is entirely legal. In 2018, ‘Congress‘ made it official that this way of getting a Roth IRA through the backdoor was legal under the law.
#3 Purchase Long-Term ETFs
Next, you’ll probably want to use your Roth IRA to ‘Purchase some long-term ETFs or Exchange Traded Funds. Also, don’t forget to fill out form 86 on your 1040 during tax time. If you are married, repeat the whole process for your spouse.
Even if they don’t have any earned income, they can still have a Roth IRA. The rule is that you can have a Roth IRA if you have at least $12,000 in earned income. So, if you’re married, you can repeat everything for your partner.
#4 Keep Doing This Every Year
And finally, ‘Keep Doing This Every Year.’ The Roth IRA is a great way to invest because your money will grow tax-free, and you’ll be able to take it out tax-free. You don’t want to miss out on that.
Before I give you an ample warning and some tips, I want to give you a quick rundown. So, those are the steps for getting a Roth IRA through the backdoor conversion. And I know it seems like a lot, but remember that it only takes a small amount of time, and your retirement will be very grateful.
Warning Of Getting Roth IRA through Backdoor
So, you probably wonder if you can still get a Roth IRA through the backdoor for the previous year. The answer is yes, but you must do it before the filing deadline for this year’s taxes. It will also make the process just a little bit harder.
The most prominent warning I have to give you before you do the backdoor Roth IRA is that you can’t have any tax-deferred money in an IRA if you want to do the backdoor Roth IRA. It isn’t true for 401K or 4 or 3 B accounts, but it is valid for these.
It is because if you have tax-deferred money in an IRA, you’ll have to do a prorated calculation that can make the benefits of the backdoor IRA null and void.
So, if you want to do a Backdoor IRA, you’ll need to ensure you don’t have any tax-deferred money in an IRA.
I wanted to keep this article short, so you could get excited about this backdoor Roth IRA and start investing immediately. However, if you’re having trouble deciding if a Roth IRA is right for you and you’re also thinking about a traditional IRA or 401k, then you should read our older article, where I compared the 401k, traditional IRA, and Roth IRA.