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“Back-door” Roth IRAs Boost Tax-Free Retirement Savings

December 20, 2019

Higher-income taxpayers can boost their tax-free retirement savings with “Back-door” Roth IRAs.

*Editor's Note: This blog was originally posted in 2014 but has been updated as of December 20, 2019 for accuracy and comprehensiveness.

Would you like to enjoy tax-free — not just tax-deferred — growth on a portion of your retirement savings? Then a Roth IRA might be for you. Contributions aren’t deductible, but qualified distributions are tax-free. That means the growth will never be subject to income tax (provided you don’t take nonqualified distributions). Unfortunately, your ability to contribute to a Roth IRA may be reduced or eliminated based on your modified adjusted gross income (MAGI).

For 2020, the MAGI phaseout ranges are:

  • Married taxpayers filing jointly: $196,000-$206,000
  • Singles and heads of households: $124,000-$139,000

If your MAGI is within the applicable range, your contribution limit will be reduced. If it’s above the range, you can’t make any contribution. Higher-income taxpayers still have a few ways to benefit from tax-free Roth savings.

What is a ‘back door’ IRA exactly?

Depending on your situation, the best option might be a “back-door” Roth IRA. How does it work? You open a traditional IRA and make a nondeductible contribution (up to $6000 in 2020, or $7,000 if you’ll be age 50 or older on Dec. 31, and no MAGI phaseout applies). You then convert the traditional IRA to a Roth IRA.

Normally the entire converted amount is taxable in the conversion year. But with a back-door Roth IRA, if you don’t have any other traditional IRAs, the only tax due will be on any growth from the contribution date to the conversion date — likely a nominal amount.

If you already have one or more traditional IRAs, you still can use this back-door technique, but you’ll trigger some income taxes on the conversion. How much depends on the size of the IRA(s). Even if you have to pay tax on nearly all of the converted amount, a back-door Roth IRA can be beneficial because it allows you to increase your total contributions to tax-advantaged accounts.

While an additional $6,000 or $7,000 a year might not sound like a lot, it can increase dramatically over time, especially when growth compounds tax-free. Would you like more information on back-door Roth IRAs or other ways to take advantage of tax-free Roth retirement savings? Please contact us.

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