In this video and article article, I want to highlight why a the back door Roth IRA contribution can be one of the most powerful wealth building strategies you can take advantage of. Please understand this article is not tax advice and the steps involved can be complicated and require additional analysis. This article stays intentionally high-level. If you would like a deeper dive into the process, I recommend watching my free webinar recording here.
The Roth IRA provides the opportunity for tax-free growth of your investments, assuming certain requirements are met. This benefit proves extremely powerful as taxes can reduce investment returns meaningfully.
Ideally, you won’t withdraw from your Roth IRA until after attaining 59.5 – an important age requirement to receive full tax benefits. Let’s assume you have a long time horizon, but you can work the math for any scenario you foresee. For this example, using 30 years worth of potential growth, at $6,000 per year of contributions, compounding at a fairly reasonable long-term return of 8% – you end up with almost $680,000 of tax-free money.
Contributing $6000 per year initially may not seem like a life-changing number. That’s the amazing effect of compounding. I’ve never met someone that told me they wouldn’t enjoy having over half a million dollars of tax free assets available when closing in on retirement.
Sounds great, but “I make too much money to contribute to a Roth IRA.” I hear this statement come up quite a bit. There may still be an opportunity to utilize the Roth IRA, but it involves some extra steps.
Enter the back door Roth IRA
As mentioned, there are income limits for making a direct Roth IRA contribution. This means that if you are over that contribution threshold, you cannot directly fund the Roth IRA.
Instead, you must first make a non-deductible contribution.
This is a contribution into a regular, or traditional IRA.
You can make a nondeductible contribution, which provides no up-front tax benefit, and then convert it over to a Roth. This process works because neither the traditional IRA nor the conversion have any income limits to them.
As long as you do not have pre-tax money in your personal financial bucket, a subject I cover in our webinar, there should be no tax applicable on the conversion. Therefore, you have now “back doored” your way into making a Roth contribution.
When to consider this option?
If you are under the income limit, you should make your contribution directly to the Roth. Once over the limit, the back door process becomes valuable to further consider. The numbers are significant, so if you can take advantage of it, it can truly be one of those life changing actions that you take on from a year to year basis. If this article has you interested, I suggest you take the deeper dive and watch my full Back Door Roth IRA webinar.
Curious if a Roth or back door Roth IRA contribution are right for you? We’d be glad to connect. Get in touch with us to speak further.