Is A Backdoor Roth IRA Right For You?

Are you interested in reducing your taxes as much as possible, but earn too much to contribute to a traditional Roth IRA?

If the answer is ‘yes’ then you may want to consider contributing to a backdoor Roth IRA. But, like with most investments, what works for one may not work for all.

Continue reading to see if a backdoor Roth IRA is right for you.

What Are The Pros Of A Backdoor Roth?

A backdoor Roth IRA is a solution for investors who have maxed out the $17,500 (with $5,000 additional catch up contributions for those over age 50) allowable contribution limit for workplace retirement plans and want to contribute more to a tax advantaged retirement account. Any money (contributed after tax) grows tax-free and is withdrawn without any further taxation.

A Roth IRA enjoy enjoys additional advantages besides tax-free withdrawals; namely, there are no required minimum distributions and the Roth IRA can be passed on to one’s heirs. (Here’s a quick primer on theRoth IRA benefits if you’d like to read more).

In general, it’s a good idea to contribute the maximum allowable by law to your workplace retirement account before creating a backdoor Roth IRA (see Retirement Savings: Start with Your 401k for more detail). And if you decide to contribute to a backdoor Roth for multiple years, the process must be repeated each year and can’t be automated.

Who Doesn't Need A Backdoor Roth IRA?

In reality, the backdoor Roth has complications that make it less appealing than it might appear on the surface. Here are the reasons you should pause before trying a backdoor Roth:

1). If you have any other deductible IRAs (for instance, an old 401k that you’ve rolled over). In this case, the conversion of any contributions becomes a taxable event that you’ll need to pay taxes on upfront.

2) If you are satisfied with the maximum retirement limit through your workplace retirement account (401k contributions are pre-tax are often accompanied by an employer match – making them the optimal retirement savings vehicle in most cases) and are not planning on additional retirement savings, you don’t need a back door Roth IRA.

3) If you already have money in a traditional IRA, because of the pro rata rule, it may not up being advantageous from a tax perspective to convert.

4) If you are unwilling to keep the funds in the newly created Roth IRA for at least five years before withdrawing the money. Because a backdoor Roth is considered a conversion and not a contribution, the funds will incur a 10 percent penalty if withdrawn within five years unless you are age 59 ½ or older.

5) If you are in a high tax bracket now and expect to be in a lower tax bracket upon retirement, you may want to keep the money in the traditional IRA.

6) If you plan to relocate to a lower income tax state or a state where there are no income taxes (Texas, Wyoming, Nevada, Alaska, Florida, Washington, and South Dakota).

7) If you are over than age 70 ½ you’re ineligible to contribute to an IRA and thus can’t utilize the back door Roth IRA strategy.