The Roth IRA is an incredible retirement investment vehicle that allows individuals to contribute after tax dollars into an account, invest in it and have all the earnings grow tax free and future withdrawals tax free (so long as certain rules are followed). The downside to the Roth IRA, for some, is that the IRS has created income limitations on who is eligible to contribute to a Roth IRA to prevent high income earners from benefiting from its tax free nature. This may be one of the only downsides to having a high income.
Income Limitations: Your income eligibility is based on your MAGI or Modified Adjusted Gross Income on your tax return. Your MAGI accounts for all of your income sources – salary, investment income, business income, etc. and is offset by a few deductions.
Single Tax Filer: You may contribute up to the maximum contribution if your MAGI is below $129,000. Between $129,000 to $144,000 your eligible contributions begin to decrease. At $144,000 and above, you are no longer eligible to contribute.
Married Filing Jointly Tax Filer: You may contribute up to the maximum contribution if your income is below $204,000. Between $204,000 and $214,000, your eligible contribution begins to decrease. At $214,000 and above, you are no longer eligible to contribute.
Utilizing the backdoor Roth IRA method is a unique way for individuals to add to a Roth IRA on an annual basis despite the fact that their income exceeds the income limitations.
The backdoor Roth IRA works like this:
Sounds a little too good to be true? The Backdoor Roth IRA method is a well recognized loophole in the industry that is, under current law, permissible and “respected” by the IRS. Read below to learn more about potential upcoming changes from the Build Back Better Act.
If you have a Traditional IRA or a Traditional 401K (that you are planning to roll over from a previous employer), you have the option to convert those accounts into a Roth IRA.
You would simply roll those IRA assets into a Roth IRA account, pay ordinary income tax on the amount that is being rolled over and then benefit from tax free growth and withdrawals for years to come.
This scenario would make particular sense for individuals who;
Now keep in mind, the Build Back Better Act is still in limbo. There is discussion around the idea that individuals who have exceedingly high income would no longer be able to utilize the IRS respected loophole of the Backdoor Roth IRA and talk about high income earners in excess of $400,000 being eliminated from Roth conversions all together.
But here’s the thing, the law has not been passed yet and when it comes to the matter of finances and taxes, it is rare that Congress passes a law that will take effect retroactively. So it will play out in 1 of 4 ways:
Despite the Build Back Better Act pending, if I were in the position where my income exceeded the income limitations and I had an additional $12,000 of cash sitting in an account waiting to be invested, here is what I would do right now to take advantage of the Backdoor Roth IRA method…
I will continue to keep you updated via Instagram on the BBB Act as new information comes about.
Tune in to weekly blog posts every Tuesday and Thursday!
Follow @finpoweredfemale on Instagram for more personal finance, tax, investing and business ownership tips on building wealth with confidence.
Read my blog post, All About Roth IRA’s and Why I Love Them to give you some additional insight into why the Roth IRA investment vehicle is such an attractive one for long term wealth building.