June 03, 2022

Can I Still Fund a Backdoor Roth IRA?

One proposed piece of the Build Back Better legislation, which failed to pass in the Senate in 2021, is closing the financial planning loophole known as the “Backdoor Roth IRA.” A Backdoor Roth IRA is a nickname for a strategy that allows you to invest in a Roth IRA even though your income is greater than the IRS limits allow. For 2022, you cannot contribute to a Roth IRA if you are single and your income is above $144,000, and your ability to contribute is limited if your income is above $129,000 (for married couples, the limits are $214,000 and $204,000, respectively).

A Roth IRA is an attractive strategy for many because, unlike traditional retirement accounts, money can be withdrawn tax-free after age 59½ from a Roth IRA if the account has been open for at least five years. In addition, there is no mandatory requirement to withdraw money from a Roth IRA after age 72, as with a traditional retirement account. This allows more time to benefit from compound growth, which can also be passed to your heirs, if desired.

How do you establish a “backdoor Roth IRA” when your income is above the IRS limits? In short, you contribute money to a traditional IRA, and simply convert the contribution made to a Roth IRA. There is no limit on the amount that you can convert to a Roth IRA, as there is with regular contribution limits to a Roth IRA. When you convert tax-deferred money from the traditional IRA to a Roth IRA, you pay taxes on the converted amount as though it were taxable ordinary income. The taxable portion converted would be considered income for the tax year in which the conversion took place.

After failing to pass the Build Back Better legislation last year, it’s likely that Congress will try to pass it again in 2022. If a version of the Bill passes later this year, the rules may go into effect immediately. It is possible, but unlikely, that the rules will be imposed retroactively to the beginning of the year. Another possibility may be that the new rules would not go into effect until the start of 2023. In short, if the Backdoor Roth IRA strategy is one you want to implement, don’t procrastinate in taking action.

As always, please consult your tax advisor to see if this is a viable option for your specific set of circumstances.

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