How to fund a backdoor Roth IRA

Ever wondered how to do a backdoor Roth IRA? It's only a few steps, but there are a few things you'll want to understand before you do this!

Transcript:

Want to do a backdoor Roth IRA and don't totally understand the rules, you're in the right place. In this video, we're going to talk all about backdoor Roth IRAs, how to do them, what they are. And by the way, this is not to be confused with the mega backdoor Roth, which is actually something to do with your 401k. That's another video. So today we're just going to focus on Roth IRAs.

Okay, so what is a backdoor Roth? A backdoor Roth is a method of funding a Roth IRA when you otherwise make too much money to fund the Roth IRA directly, which I suppose is through the front door. But ultimately, let's just break this down. So first you have to understand that there are income limits in funding a Roth IRA and actually an IRA. So for 2023, the income limits for married filing jointly are $228,000. If you make more than that for married filing jointly in 2023, you can't fund a Roth IRA directly. Just Google these income phase outs if you're curious in any given year. Separately, if you make more than $136,000 in a year and you're married finally and jointly, you can't take a deduction if you fund a regular IRA.

The key phrase there is take a deduction. So anybody at any income level can fund a regular IRA. It's just that depending on how much you make dictates if you could take the deduction or not.

Also, and separately, anybody at any income level can perform what's called a Roth conversion. So let's put this together. Anybody at any income level, you can make $10 million a year and you can fund a regular IRA. And then you can convert that regular IRA over to a Roth IRA. Because you funded the regular IRA with money that was already taxed. So after tax contribution, the conversion from IRA to Roth IRA is completely tax free. That's it. You're done. Step one, fund IRA.

Step two, convert to Roth. Step three, invest the money, but that's it. In 2023, the limit is $6,500. That's the IRA limit. Each person can have one IRA. If you're 49 and younger, that's your limit. If you turn 50 in 2023, or you are already 50, you can add a thousand dollars to that, which is called a catch -up contribution. So you can put a total of $7,500 in your IRA. Okay. A couple other things to know.

Since you didn't take a deduction on that IRA contribution, that's why the conversion over to Roth is tax free. If you say, put money in the IRA, $6,500, you invested it and it grew to say $7,000 and you converted it to Roth, that extra $500 would be taxable income to you. It's not the worst thing in the world, just saying it so you know how this works.

It's also worth noting if you have IRA money, you can't do this because it's not totally accurate. You can still do this if you have other IRA money but it wouldn't be all tax free. Let's say that you have a hundred thousand dollars in an old IRA. That's a rollover from an old 401k and you opened up a new IRA and you funded it with $6 ,500 and you converted it over to Roth. The IRS wouldn't allow you to just pick that IRA because it's tax free. They would make you aggregate the two IRAs together to determine how much of that conversion is tax free. How much of that conversion is.

I won't go into the details here. Bottom line is if you have another IRA, you might Google the IRA aggregation rule to understand how the taxation of this would work. We generally tell people if you have another IRA, don't do this. With that said, if that IRA is very small, you might consider converting it because paying some tax on that conversion might make sense to then simply open up the door to do these backdoor Roth contributions for you every single year moving forward. So the law continues to allow this because it's a decent tax planning strategy or could be a decent tax planning strategy for your plan.

Lastly, if you have a spouse or you are a spouse who is not working, you can still do this. So you have to have income in order to fund an IRA, at least enough earned income to fund an IRA. So $6 ,500 or between the two people that are say under 49 years old, 13 ,000 between the two again here in 2023. If one spouse is working and one spouse is not working, you can still do this.

Okay, that's it. I definitely did not cover all the technical aspects of this in this video, but that helps at least with the basics of how to do a backdoor Roth IRA. If you found this video helpful, please like and subscribe to our channel for additional updates.