Roth IRA Contributions Vs. Backdoor Roth Vs. Roth Conversions

Dec 22

Even though the word "Roth" is being used in all 3 categories, they all work a bit different. We all know at this point that Roth money is contributed using after-tax dollars which grows on a tax-deferred basis and could be used or withdrawn after Age 59.5 on a tax-free basis. It's like the gift that we all want, tax-free savings. But today, we are going to identify the difference between Roth IRA contributions, Backdoor Roth, and Roth Conversion.

Roth IRA Contribution

In simple terms, if your income is below the IRS threshold (< $146k for single filers and <$230k for those filing Married Joint Returns in 2024), your employer doesn't provide a Roth 401(k) option, you lack any Employer Retirement Accounts, or you're self-employed with modest earnings, you have the flexibility to contribute up to $7,000 to a Roth IRA. Additionally, individuals aged 50 and above can contribute an extra $1,000.

Backdoor Roth

But what about those who earn more than $146k as Single Filer or $230k as Married Filing Jointly Filers? Unfortunately, they cannot directly contribute into a Roth IRA because their income is too high, HOWEVER they do have another option available – That’s called the “Backdoor Roth IRA”. Now there are several nuances to a backdoor Roth IRA so we must be really careful. First, we must make sure we have no other Traditional or Rollover IRA accounts under our name (401(k) accounts are okay). Once we can make sure we don’t have a single dollar in a Traditional or Rollover IRA, the backdoor IRA strategy can be implemented. Simply do this – establish 1 Traditional IRA and 1 Roth IRA, contribute the allowable amount into the Traditional IRA but make sure to elect the contribution as a “Non-Deductible Contribution” so it makes sure your IRA contribution is not deducted on your tax return, then, instead of investing that money in the traditional IRA, move that money into your Roth IRA as a “Backdoor Contribution”. This will successfully complete your backdoor roth conversion.

Roth Conversions

Now, let's address those individuals with Traditional or Rollover IRA funds who find themselves above the IRS Threshold. Fear not, there's a plan for them too—the Roth Conversion Option. The essence of a Roth Conversion strategy lies in the scenario where a person possesses Traditional IRA funds (pre-taxed), unable to transfer them into an Employer-sponsored Retirement account and exceeds the income threshold for direct contributions to a Roth IRA. In such cases, the Roth Conversion strategy comes into play. However, it's crucial to grasp the significance of determining the amount of money for conversion based on your effective tax rate.

Ultimately, the choice boils down to your individual financial circumstances. That's why collaborating with a fiduciary, a fee-only financial planner with a wealth of experience, is crucial.

I am Raman Singh, a Certified Financial Planner™, Your Personalized CFO at Singh Private Wealth Management. My vision is to empower my community by providing guidance, coaching, and courage to help them achieve happier and healthier lives.