President of Pure Financial Advisors, Joe Anderson, CFP® explains that a backdoor IRA is a tax loophole; it allows individuals and married couples to contribute to a Roth IRA if they otherwise wouldn’t qualify.
“Joe Anderson here, CERTIFIED FINANCIAL PLANNER™, President of Pure Financial Advisors, and welcome to Question of the Week. I’m getting this question quite a bit: what is a backdoor Roth IRA? The back to a Roth IRA is a tax loophole. It allows individuals and married couples to contribute to a Roth IRA if you otherwise wouldn’t qualify. There are qualifications to do a Roth IRA contribution; the AGI [Adjusted Gross Income] limits are $193,000 if you’re married and $131,000 if you’re single. If you make too much money the IRS does not allow you to directly put money into a Roth IRA. However, what the IRS code says is that anyone can contribute to a traditional IRA as long as you’re under 70 1/2 and have earned income. So if I’m making too much money where I can’t put it directly into a Roth IRA, I CAN put the money into a traditional IRA. If I’m under 50, the contribution limits are $5,500.
Here’s the example: I’m making too much money and I’m a married man. My AGI limitations are $193,000 assuming I’m making $200,000 a year. I can then take my $5,500 contribution and put that directly into an IRA (a traditional IRA). Because I’m making $200,000 I cannot take the tax deduction, so what is called basis in that IRA is an after-tax contribution. I can take that after-tax contribution and then directly convert that into a Roth IRA because there is no AGI limitations for Roth IRA conversions, hence the word backdoor. I have to take two steps here: I have to go to the traditional IRA first, and then I can convert it into the Roth IRA no matter what my income is. Here’s the catch: if you have any other IRAs, then you have to look at the pro rata and aggregation rules. It gets a little complex, so I would highly recommend talking to a qualified advisor or your CPA.
I’m Joe Anderson, and this was your Question of the Week.”