Why contribute to a Roth IRA? Roth IRA contributions are not deductible on your income tax return as a traditional IRA is, however, Roth IRA accounts grow tax-free and withdrawals are not subject to income tax. The growth in the Roth account can be substantial and not paying tax on that growth can yield a large tax savings.
Will You Benefit from a Backdoor Roth IRA?
Taxpayers who participate in a retirement plan through work and whose income is over the income threshold are ineligible to contribute to both Roth and Traditional IRAs. For 2023, the Roth threshold amounts are $138,000 for Single/Head of Household and $218,000 for Married Filing Jointly for Roth IRA. A Backdoor Roth IRA is a legal way to circumvent those income limitations so they can contribute up to $6,500 (individuals under 50) and $7,500 (individuals 50 and older).
How Does a Backdoor Roth IRA Work?
With a Backdoor Roth IRA, the taxpayer makes a nondeductible contribution to a Traditional IRA and then immediately recharacterizes (converts) it to a Roth IRA. The taxpayer then reports this on Form 8606 Nondeductible IRAs so that the IRS is aware it was not deducted and there will be no tax on it when converting to the Roth account.
The key takeaway here is even though you do not get the current tax benefit of a deduction via the Traditional IRA you still can contribute to a tax-deferred (Qualified) plan to get tax-free growth, which will not be taxed when distributed if it has been five years since the Roth conversion. Distributions prior to the five-year holding period will be subject to penalty.
Working With a Financial Advisor
If you plan on doing this for 2023, please work with your financial advisor so the appropriate accounts are funded, and the conversion is properly coded for tax reporting purposes. Also, make sure you inform your tax accountant, so it is properly reported on your 2023 income tax return.
Backdoor Roth conversions are most useful to high earners with access to workplace retirement plans. They are not eligible for traditional or regular Roth contributions but are allowed to convert a traditional to a Roth without penalty.