The theme this week is the backdoor Roth IRA strategy. If you make too much money to qualify to make a Roth contribution in 2019, don’t fret. There is a little-known strategy called the backdoor Roth, that will still allow you to make Roth contributions. 

Here’s how it works: You make a non-deductible or after-tax IRA contribution to your Traditional IRA. There aren’t income limits on conversions from a Traditional IRA to a Roth IRA, so you can then turn around and convert that contribution to a Roth. Bam. Done. Take that Uncle Sam!

2 important things I need to point out here, and it’s important that you understand this, because there are a couple of circumstances where you could still owe a substantial amount of taxes by using the backdoor Roth: 

1. Pro rata rule - when you report the Roth conversion on your taxes, you’ll also need to include the total value of your IRA accounts, like SEP IRAs and Traditional IRAs, because this total value of existing IRA assets that you have is used to calculate the taxes on the amount you convert. Keep in mind that 401k balances aren’t included in this. The bottom line here is that if you have a lot of money in tax-deferred IRA accounts, you could be faced with a tax bill on the amount you convert to a Roth, so be sure to run this strategy by your tax advisor before you pull the trigger, so they can estimate what that tax hit might be for you.
2. Taxes on gains - if you invest the money you contribute to your IRA before converting it to a Roth and it grows in value, you could also pay capital gains taxes on the amount you convert, so you may want to consider just leaving any IRA contributions in cash before you convert to the Roth, to keep any gains to a minimum.

The takeaway here is that a Backdoor Roth is worthwhile if your income is too high to qualify for the Roth, but as always, the rules can get a little complicated, so check with your tax advisor to make sure you don’t have any surprises come tax time next year. 

Thanks for listening. My name is Ashley Micciche and this is the One Minute Retirement Tip. 

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