Backdoor Roth IRA: Advantages and Tax Implications Explained
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- 08 January 2021
If you put it into a traditional IRA it is going to cause any future Backdoor Roths to be pro-rated. Better options include leaving it where it is; rolling it into your new employer’s 401(k) or 403(b); rolling it into your individual 401(k); or, if it is small, just converting the whole thing to a Roth IRA. Your Roth IRA contributions will need to go through the “backdoor” many times as you build your portfolio.
There should be no additional tax due from contributing to an IRA indirectly via the Backdoor Roth IRA process. Hit continue and you’ll go back to the Deductions and Credits menu. Next, convert the non-deductible traditional IRA to a Roth IRA by transferring the money from your traditional IRA into your Roth IRA at the same fund company. If you don’t already have a Roth IRA there, you’ll need to open one. This can be done in a minute or two online at Vanguard, and it is essentially the same process as opening the traditional IRA.
First, you, as a high earner, get no IRA deduction despite contributing $6,000-$12,000 to IRAs for the year. Second, now that you’ve entered your conversion and contribution, the amount of tax due as calculated by Turbotax in the upper left (“Federal Refund $0”) hasn’t changed. That shows you that you did the whole process correctly.
- You can also file taxes on your own with TurboTax Premium.
- Hi, I found another way around this problem.
- Married physicians should be using a personal and a spousal Roth IRA, and you will usually need to fund both indirectly (i.e., through the Backdoor).
- That could kick you into a higher tax bracket that year; however, you may not have to pay tax on all the money; a pro-rata rule applies to prevent taxing the amounts attributable to after-tax contributions.
I wish Congress would just lift the rule against direct Roth IRA contributions for high earners and save us all this hassle, but who knows if that will ever happen. Do yourself a favor and just empty the darn IRA by December 31. Keep in mind that this is usually not an instantaneous https://turbo-tax.org/ process, so don’t put it off until you’re on holiday break at the end of the year. If you read Form 8606, you will see that the only time it ever mentions a recharacterization is to tell you NOT to put it on the form. Bear in mind that there are other MAGIs out there.
Married physicians should be using a personal and a spousal Roth IRA, and you will usually need to fund both indirectly (i.e., through the Backdoor). This provides an additional $7,000 each ($8,000 for each spouse that is 50+) of tax-protected and (in most states) asset-protected space per tax year, and it allows for more tax diversification in retirement. Tax diversification allows you to determine your own tax rate as a retiree by deciding how much to take from tax-deferred (traditional) accounts and how much from tax-free (Roth) accounts. Remember that IRA stands for INDIVIDUAL Retirement Arrangement, so even if the pro-rata rule (discussed below) keeps you from doing the Backdoor Roth IRA, it doesn’t necessarily keep your spouse from doing so. Each spouse reports their Backdoor Roth IRA on their own separate 8606, so the tax return for a married couple doing Backdoor Roth IRAs should always include two Form 8606s. You’ve now fixed your mistake in the eyes of the IRS, going from an illegal Roth IRA contribution to a legal traditional IRA contribution (that is probably not deductible for you).
The most important lines to check are lines 15c and 18. If you did the Backdoor Roth IRA correctly, these should both be $0. If it’s $6,000, you entered it into Turbotax incorrectly and need to start over. This is an important box to get right, and it’s important to make it zero too! This line goes directly to line 6 of Form 8606.
Is a Backdoor Roth Still Allowed?
Therefore, it is critical that you DO SOMETHING with any IRA balance you have PRIOR to December 31 of the year in which you do a Roth conversion of after-tax money. Later in this article, I’ll describe the exact options you have for what to do with this money. How much can that tax protection be worth compared to a taxable account? It depends on the return of the underlying investment, its tax efficiency, and the amount of time the money is left in the account. At my marginal tax rate, $10,000 earning 8% in a tax-inefficient investment over 50 years would grow to $469,000 in a Roth IRA but only $88,000 in a taxable account. More realistically, over 30 years, the use of a Roth IRA vs. a taxable account for a tax-efficient investment would still result in 29% more money.
We’re only talking about the one that affects Roth IRA contributions here. But to get your MAGI, you simply take your AGI, you subtract some income from it, and you add back in some other income to it. The worksheet showing you how to do this is Worksheet 2-1 in Publication 590.
As a result, the backdoor Roth IRA has become a tax-planning opportunity for higher-income taxpayers who ordinarily couldn’t contribute to a Roth IRA. Contributions to a Roth IRA, in contrast, are made with after-tax dollars and are not tax deductible. You get years of tax-free growth just like a traditional IRA. But with the Roth IRA, there is generally no income tax on withdrawals as long as you’re older than age 59½ and have held the Roth IRA for at least five years. Additionally, you don’t have to take any distributions during your lifetime.
Do I Need to Worry About the Step Transaction Doctrine?
If it is small, convert it to a Roth IRA along with this year’s traditional IRA contribution and pay the tax due on it. If large, try to roll it into your employer’s 401(k) or if you have self-employment income, into your individual 401(k). Below are the MAGI limits for direct Roth IRA contributions . If your MAGI is below the first number, you can just contribute to a Roth IRA directly. If your MAGI is over the second number, you cannot contribute at all. If your MAGI is between the two numbers, you can make a partial direct contribution (most shouldn’t bother with this, just do it all through the Backdoor).
How do I enter a Backdoor Roth IRA contribution?
However, annual contributions to Roth IRAs are capped at $6,500 ($7,500 if you are age 50 or over) in 2023, so the big payoff from converting is when you convert a sizable existing traditional IRA to a Roth IRA. By converting you change otherwise taxable distributions to tax-free distributions. You’ll have to pay tax now on the amount you convert. As long as you didn’t have any earnings between when you contributed to your Traditional IRA and when you did your backdoor conversion to a Roth IRA, your Taxable amount should show as being zero. If you did have earnings between the contribution and the conversion, then they’ll still be taxable and will show up here.
Tax Implications of a Backdoor Roth IRA
If this number isn’t $0, you’re going to have your conversion pro-rated. Next, it asks about non-deductible contributions. Note that you’ll see this question when you get to the contribution section too. You’ll eventually come back to the same page. Doing a backdoor Roth conversion is a two-step process.
How to open a backdoor Roth IRA
So, if your other Traditional IRA account(s) is proportionally high on the pre-tax side, then more of the amount that was converted to the Roth will be taxed. The Backdoor Roth IRA process leads to more tax-free retirement account money for doctors and other high-income professionals. If you follow the simple steps outlined above, you will pay less in taxes, boost backdoor roth ira turbotax your returns, facilitate your estate planning, and increase your asset protection. Most members of The White Coat Investor community do these every year, and you should too. The first income line you come to is line 7b, your “Total Income.” When people think about income, this is generally what they think of. The third income line on the form is line 11b.