We have talked a lot about the Wonder of a Roth IRA, but did you know some people are not eligible? Singles earning more than $165,000 and married couples with a combined income greater than $236,000 are ineligible for Roth IRAs. So are married individuals earning more than $10,000 who file their taxes separately. If you want a Roth IRA but fall in one of these categories, what should you do?

Backdoor Roth IRA

A backdoor Roth IRA is a perfectly legitimate way for those who are ineligible for a Roth IRA to get one anyway. Despite the name, there is nothing shady or illicit about a backdoor Roth IRA. The method outlined here has been approved by congress and codified into law by the IRS.

Simply stated, a backdoor Roth IRA is a traditional IRA that has undergone a Roth conversion. The process is not that difficult.

This is How We Do It

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EGGSTACK RETIREMENT PLANNER

Terminology:

• Contribution: Money placed into an investment account.
• Distribution: Money taken out of an investment account, typically in retirement.
• IRA: Individual retirement account.
• Required minimum distribution: Government-mandated withdrawal from pre-tax investment accounts after the account holder has reached 72 years of age.
• Roth IRA: Contributions are not tax-deductible, distributions are tax-free.
• Traditional IRA: Contributions are tax-deductible, distributions are taxed as ordinary income.

if you do not already have one, the first step in doing a backdoor Roth IRA is to open a brokerage account. Any one will do – Vanguard, Charles Schwab, Fidelity, TD Ameritrade.

Next, fund the brokerage account. If you are 50 years of age or older, you can put a maximum of $8,000 per year in an IRA. Otherwise, the annual limit is $7,000.

The easiest way to fund your brokerage account is to link it to your bank account. Starting with your brokerage account, link it to your bank account via the bank’s routing number and your account number. This can take a few days and usually involves your brokerage depositing two small amounts into your bank account so they can confirm it’s your account. Once that has been established, the link is used to pull funds from your bank into your brokerage account. The same link can be used to push funds from your brokerage to your bank account. 

Open a traditional IRA at your brokerage. Fund it from your settlement account which is like an interest-bearing holding cell for unassigned funds. Choose an investment. We’re not going to get into it here because it is beyond the scope of this article, but choose wisely and keep in mind this isn’t Vegas.

Next, open a Roth IRA at your brokerage. Go into your traditional IRA account and convert it to a Roth IRA. Every brokerage does this differently; you may be asked where the funds in the traditional IRA are going, to which you answer the Roth IRA.

The last step is to file form 8606 with your federal tax return in the year that you do the Roth conversion. Part 2 of form 8606 is where the conversion of a traditional IRA to a Roth IRA is reported.

Conclusion

If the entire process takes you more than an hour, you’re doing something wrong. A backdoor IRA is perfectly legal and it is neither hard nor time-consuming. You will be rewarded in retirement with a beautiful stream of tax-free income. 

Think how smart you will look when you’re hanging out with your retired friends. While they are grumbling about required minimum distributions pushing them into higher tax brackets and making their Social Security benefits taxable, you can laugh and tell them you pay no taxes and you don’t even file a return.

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