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Pros and Cons of a Backdoor Roth IRA

Pros and Cons of a Backdoor Roth IRA

Most people’s eyes light up when they hear the words ‘tax-free’ and they’ll do anything to give as little to Uncle Sam as possible. A Roth IRA can seem like the perfect retirement account where investment growth and distributions after 59 ½ are tax-free. You choose to pay taxes now to avoid paying them later. This is extremely attractive when you may anticipate making more income and being in a higher tax bracket in the future, or even when considering the current historically low tax rate environment that we live in now. However, not everyone is eligible to contribute to a Roth IRA.

What is a Backdoor Roth IRA?

This is a two-step process where a contribution is made to a Traditional IRA and then a Roth conversion is completed.

Why do a Backdoor Roth IRA?

Those with incomes higher than $140,000 if you are single and $208,000 if you are married filing jointly, cannot contribute to a Roth IRA account directly.


1. Rachel (63 years old) earning $75,000/year and has no employer plan

Rachel can contribute $7,000 ($6,000 plus the $1,000 catch-up contribute after age 50) to a Roth IRA

2. Rahul earning $100,000/year and contributing to his employer retirement plan married to Anjali a stay at home mom.

Rahul and Anjali can both contribute $6,000 to Roth IRA accounts

3. Jenn and Joe earning $220,000 each and both contributing to their employer retirement plans.

Jenn and Joe cannot make a Roth IRA contribution or deduct their traditional IRA contribution. There best option is a Backdoor Roth IRA contribution.

The Pros

  1. You can continue to contribute to a Roth IRA even though your earnings are above the income limit permitted for a direct Roth IRA contribution

  2. You eliminate tax drag which allows you to reach your goals sooner. Tax drag is the reduction in investment returns due to taxation which apply to non-qualified or taxable accounts.

  3. It simplifies estate planning. Retirement accounts do not go through the probate process which reduces costs and maintains privacy.

  4. Your annual contributions to your Roth account will continue to be tax-free, thereby increasing your tax diversification in retirement.

  5. Asset protection from bankruptcy up to a limit ($1.36MM for 2021)

The Cons

  1. If you make a distribution from a Roth IRA account before age 59 ½, without an approved exception*, there will be a 10% penalty

  2. If you have any traditional IRAs, SEP IRAs or SIMPLE IRAs, the pro-rate rule applies which means part of the conversion will be taxable. To avoid this it is imperative that you convert or rollover these accounts into a 401(k) before December 31st of the year in which you do a Roth conversion.

  3. If you do the Backdoor Roth IRA you will need to file IRS Form 8606 per spouse.

As a high-income professional, by just following a few steps, a Backdoor Roth IRA results in paying less taxes, improving your returns, helps with estate planning and asset protection.

Adviso Wealth is dedicated to working with people just like you. We want to give you the clarity and confidence you need to achieve your personal and financial goals.

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