Tax Planning Techniques and the Rise of the Backdoor Roth IRA
The Roth IRA has been one of the best tax planning techniques to come out of Washington, DC in a very long time. But because the Roth comes with income limit eligibility limitations; (maximum income for singles in 2013-$127,000) and (maximum income for married couples-$188,000), lots of high income earners have been unable to take advantage of this option.
Like many of you, including yours truly, that have already received loads of info about the ‘backdoor Roth IRA’ from tax planning firms or your CPA, below is a consolidation of the best of the best that I have received recently on this topic. All due credit belongs to the numerous sources that kindly sent me info about the new ‘tax kid’ on the block - the backdoor Roth IRA - thank you!
The Advantages of a Roth IRA
The beauty of the Roth IRA, even with the restrictions, means contributions to a Roth IRA can be withdrawn, along with growth, tax free. Compare that to a traditional IRA, where you can begin withdrawals without penalty post 59½, yet any money you withdraw from your traditional IRA will be 100% taxable.
Even though the contributions to a Roth IRA are not tax deductible, the ability of those contributions to grow tax free is very significant.
Although your income may be too high to contribute either to a deductible IRA or a Roth IRA, you can still contribute to a non-deductible IRA. That’s where the backdoor IRA becomes a tax planning technique.
Simply open a nondeductible IRA (even if you don’t already have one) and make a contribution before April 15, 2013 (for 2012). After you have made the contribution to the nondeductible IRA, you can convert the nondeductible IRA to a Roth IRA.
The maximum contribution for 2012 is $5,000($6,000 if you’re 50 or older). For 2013, the maximum contribution is $5,500($6,500 if you’re 50 or older).
One very important aspect to understand prior to deploying this tax planning technique is to realize that this technique only works for those who do not have other deductible IRA accounts (i.e. IRA accounts with pretax contributed money) at the time of converting your non-deductible IRA to a Roth IRA. If you have other deductible IRA accounts at the time of conversion, a portion of the conversion will be taxable. Please click on the links below for possible solutions to dealing with this situation.
As with all tax planning techniques, it is important that you review this technique with your tax advisor. The above is a summary and condensed version from the many emails that I have received from various CPA’s and a few clients as well as the website links below. Your tax advisor can provide you the expanded version; it may or may not be right for you. Before taking any action, please fully understand that it may result in unexpected taxable income.
Income Too High for a Roth IRA? Try sneaking in the backdoor by , NerdWallet
The Backdoor Roth IRA, Advanced Version by Ashlea Ebeling, Forbes
Using Non Deductible IRAs to Get Money Into a ROTH-Non Deductible IRA Rules You Can Use by Dana Anspach, About.com
The other way to invest in a Roth IRA b @Money
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