Backdoor Roth IRA

A backdoor Roth IRA can boost your retirement investment. An IRA is a specific type of retirement account that can help take some of the uncertainty out of the future. The backdoor Roth IRA offers an alternative route to a Roth IRA account. A backdoor Roth IRA does not refer to a specific type of IRA account. Consult with a financial professional about your situation to understand what works best for you. Consider your retirement options and decide what Roth account and investment options can create the retirement plan of your dreams. 

What is a Backdoor Roth IRA?

A backdoor Roth IRA is not a specific type of IRA. The backdoor Roth IRA references a specific action that happens between a traditional IRA and a Roth IRA. In summary, a backdoor Roth IRA happens when you move funds from a traditional IRA into a Roth IRA to receive the benefits provided by a Roth IRA account. 

IRA stands for an individual retirement account and it’s a specific type of savings account designed to help you plan for retirement while offering certain tax advantages. IRAs are a type of retirement account that was first created in the 1970s and are still around today. Such special savings accounts are ideal for long-term growth. 

Two types of IRAs exist — the traditional IRA and the Roth IRA. A traditional IRA uses pre-tax income and is subject to taxes during the time of withdrawals. In contrast, a Roth IRA allows for investments into the account using after-tax income. That means the investments placed within a Roth IRA typically are not taxed again during the time of withdrawal. 

Both types of IRA accounts only allow earned income. The term earned income might seem simple, but it stipulates that the only type of income that’s allowed in the accounts for savings and investments must come from working for someone else or owning your own business. For example, some types of income that do not qualify as earned income for IRA accounts are child support, social security and other income. Typically, you cannot contribute to an IRA account without earned income from one of the allowed methods. 

No set age minimum is established for opening an IRA account, so you can open one early and begin investing once you’ve begun to earn income. Although a child might earn income as an actor or influencer, most little kids don’t earn income, so they would not be able to contribute earned income to an IRA. Investing early can be beneficial because it allows your investments within the account the ability to grow over time and weather changes in the market. 

Although retirement might seem abstract at a young age, investing early can help create a much-appreciated level of financial stability later in life. However, if you are closer to retirement, then an IRA account might still prove beneficial. Before placing your investments into an IRA, note the five-year rule on withdrawals of investment earnings. This rule specifies that Roth IRA earnings cannot be withdrawn tax free within the initial five years.

In other words, if you deposit $2,000 in a Roth IRA in 2020 and your investment earns $500, if you withdrew the entire $2,500 in 2022, you would have to pay tax on that $500 of earnings — but not on the $2,000 contribution. You don’t have to pay tax on the contributions in a Roth IRA because those are made with money you earned from working and have already paid tax on. In this example, the $2,000 you contributed could come out without being added to your taxable income in 2022, but the $500 would be taxed.

Overall, a backdoor Roth IRA refers to an action between traditional IRA accounts and Roth IRA accounts. It's not an additional account option. 

How Does a Backdoor IRA Work?

Backdoor Roth IRAs typically happen when funds and investments that are placed into a traditional IRA are moved into a Roth IRA. When this happens, you must typically pay taxes. It’s a back door to achieving a Roth IRA because this process is not limited by your level of income. A Roth IRA account can be considered a favorable form of IRA account because it helps to facilitate tax-free future withdrawals on investments while allowing investments within the account to grow and increase without additional taxes.

A Roth IRA provides a certain level of financial comfort because investments in the account cannot be lost to additional taxes. For example, a Roth IRA allows a wide range of investments such as stocks and ETFs, and these investments can grow and receive interest without facing additional taxes. 

Review your current and future tax bracket expectations before executing a backdoor Roth IRA.

Why Would You Use a Backdoor Roth IRA?

Using a backdoor Roth IRA can help you if you technically make too much money to qualify for a Roth IRA account. A Roth IRA account has tax bracket limitations and is typically accessible for lower tax brackets. Roth IRAs offer clear income limits that are designed to easily define which people are allowed to open and access such a special savings account. The income limits are broken down as a single income as well as the limitations placed on people that jointly file income. 

The backdoor Roth IRA allows you to move investments from a traditional IRA account into a Roth IRA. This move can prove beneficial if you expect larger returns on your initial investment over time because a Roth IRA offers a certain level of tax sheltering not offered by a traditional IRA. In addition, Roth IRA accounts and traditional IRA accounts both have similar annual contribution limitations.

For example, if you are age 50 or older, you can make an IRA catch-up contribution of an additional $1,000 for a total of $7,000 in 2022. 

Where Can You Get Into a Backdoor Roth IRA?

When thinking about opening and using a backdoor Roth IRA, choose an account manager that works well for you. You can access a wide range of financial services prepared to help with backdoor Roth IRAs. For example, Rocket Dollar allows backdoor Roth IRAs and advises that you need to have both a traditional IRA and a Roth IRA before you begin the process. 

A Roth conversion is a legal, tax-based process and should be handled with attention and care. Currently, Rocket Dollar does not allow transfers from outside traditional IRAs to a Rocket Dollar Roth IRA. However, Rocket Dollar allows for transfers between traditional IRAs and Roth IRAs that are created within Rocket Dog. 

Compare IRA Providers

Benzinga offers helpful insight into different IRA providers. Research options and consult with a financial advisor before making a decision. Both traditional IRAs and Roth IRAs offer benefits that can help you to better prepare for your retirement. Understand how both accounts work to have a better grasp on which account would best benefit your lifestyle. Before investing, understand your needs, level of risk and overall financial goals. 

Conclusion

Overall, using a backdoor Roth IRA can prove beneficial for people who cannot typically enter a Roth IRA. This action can help you achieve a Roth IRA account and receive the tax benefits provided to the specific retirement account. However, this action might not work in your favor, so speak with a professional before taking action.

Certain financial companies can help facilitate the backdoor Roth IRA process and provide an elevated level of clarity on the needed steps. In addition, the backdoor Roth IRA might not be allowed for much longer, so your investment time frame might not align with current opportunities. 

Frequently Asked Questions