What are Backdoor Roth IRA's?

What are Backdoor Roth IRA's?

June 15, 2023

What are backdoor Roth IRA's? Paul L. Moffat, President and Senior Financial Planner at Arista Wealth Management, explains in the newest episode of Arista Advice!

Full transcript:

Hello, welcome to Arista Advice! Question of the week is: "Paul, everyone's talking about a backdoor Roth IRA. What is a backdoor Roth IRA?" Backdoor Roth IRAs are great vehicles, but you got to use them right, because there's some do's and don'ts.

So let's talk about some of the do's and don'ts of a backdoor Roth IRA. There are no income limits for converting traditional IRA funds into a Roth IRA. As you'll see here, the diagram shows the process of setting up a backdoor Roth IRA. You start with a taxable asset that has already been taxed. If your income is below the yearly threshold, you can go directly to a Roth IRA. If it is not and you're a high wage income earner, then you have to take a two step approach to a backdoor Roth IRA, thus contributing to an IRA in a nondeductible manner. You then convert to an Roth IRA. Now, this will trigger a taxable event because you're pulling money out and putting it into a tax deferred, so you have to do the calculation to see if it's beneficial for you and your spouse to determine the effectiveness.

Also, with a backdoor Roth IRA, you have the ability to withdraw these funds tax-free during retirement. There's a five year rule that the money has to be seasoned to be able to pull that money out in the Roth IRA. Another benefit is it allows greater flexibility in estate planning. The great thing about these assets is the primary beneficiary would be your spouse or partner, and there is no RMD. They can keep the money, and it continue to grow tax-free because there's no forced distribution, and then at they're passing, if that asset is still growing, it then can go to their primary beneficiary, which are usually their children, and the money has to be taken out within ten years. So this money has a great potential to grow and grow and grow over many decades. 

So, in conclusion, the backdoor Roth IRA can be an excellent way for high income earners and investors to invest in tax efficient retirement accounts that can provide significant benefits in the long-term. 

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