Maximizing Your Retirement Savings with a Roth IRA or Backdoor Roth IRA
What is the Max Income for a Roth IRA?
Roth IRAs are a popular retirement savings vehicle due to their tax-free growth and tax-free withdrawals in retirement. However, your ability to contribute directly to a Roth IRA is subject to income limits set by the IRS. For 2024, the income limits for Roth IRA contributions are as follows:
Single Filers: The ability to contribute to a Roth IRA starts to phase out at a modified adjusted gross income (MAGI) of $146,000 and is completely phased out at $161,000.
Married Filing Jointly: The phase-out range starts at $230,000 and ends at $240,000.
If your income exceeds these limits, you are not eligible to make direct contributions to a Roth IRA. But don't worry, there is a workaround known as the Backdoor Roth IRA.
What is a Backdoor Roth IRA?
What if your income exceeds the Roth eligible limits? A Backdoor Roth IRA is a strategy that allows high-income earners to still take advantage of a Roth IRA.
Understand the Pro Rata Rule
Be aware that if you have pre-tax funds in any Traditional, SEP, or SIMPLE IRAs, the conversion will be subject to the pro-rata rule, which can make the process more complex and may result in a tax liability. We advise checking with your tax professional or advisor if you have existing IRAs that would be subject to the pro-rata rule. Making a mistake can result in an unpleasant tax surprise.
Assuming you aren’t subject to the pro-rata rule, here’s how a Backdoor Roth IRA works:
1. Contribute to a Traditional IRA: First, make a non-deductible contribution to a Traditional IRA. There are no income limits for making non-deductible contributions to a Traditional IRA.
2. Convert to a Roth IRA: Once the funds are in the Traditional IRA, you can convert the amount to a Roth IRA. This process is known as a Roth conversion. Be sure to move the funds to Roth immediately after funding to avoid earnings on the contribution.
How Much Can You Contribute to an IRA?
For 2024, the maximum contribution limit is $7,000, or $8,000 if you’re age 50 or older.
What is IRS Form 8606?
If you do a Backdoor Roth IRA be sure to file Form 8606 with your tax return for the year of the contribution to report the non-deductible contribution and the conversion.
Considerations and Potential Pitfalls
Tax Implications: If you have other pre-tax IRA balances, the pro-rata rule applies, potentially making some of the conversion taxable. Consult with a tax advisor or advisor to understand the implications.
Timing: Convert the funds immediately after the contribution to minimize earnings, which could be taxed during conversion.
Future Legislation: Stay informed about potential changes in tax laws that could impact the viability of the Backdoor Roth IRA strategy.
Conclusion
Even if your income exceeds the limits for direct Roth IRA contributions, the Backdoor Roth IRA strategy can provide a valuable opportunity to benefit from the tax advantages of a Roth IRA. By following the steps outlined and consulting with a financial advisor, you can effectively navigate the rules and maximize your retirement savings.
If you have any questions or need assistance with the process, our team of experts is here to help you make the most of your retirement planning strategies.