Blog Post Financial Planning

We frequently get asked, “Can I contribute to a Roth IRA even though the IRS says I make too much money to do so?” The answer is, absolutely! If you fall into that category, creating a Backdoor Roth IRA is a relatively simple process to help get around this issue.

What you’ll want to do is open up two separate accounts – a traditional and Roth IRA. Since traditional IRAs have no income limits, you’ll fund that account. For people under 50, the limit in 2023 is $6,500 and for those 50 and up, the most you can put into an IRA account is $7,500 annually. These limits change from time to time, as the IRS adjusts them for inflation, so bear in mind these are the limits for 2023.

Once your traditional IRA has been funded, you’ll convert or transfer the funds to your Roth IRA account. Since you typically get a tax break in the year you contributed to a traditional IRA, when those funds get converted (and whatever growth was realized) you’ll get taxed at the income tax bracket you are at for the year. For example, if you contribute $6,500 to your traditional IRA and claim a $6,500 deduction on your tax return, you’ll owe income tax on the $6,500 when you convert it to a Roth IRA. You will also owe income tax on the growth of those converted dollars. If you contribute after-tax dollars to a traditional IRA, you will not be taxed upon converting them to a Roth IRA.

Will I get penalized if I’m under 59 1/2?

To convert traditional IRA funds to a Roth IRA you’ll incur no penalties, because you’re only transferring the money and not cashing in your account (a.k.a touching the money).

Will I still need to take a required minimum distribution if I convert funds to a Roth IRA?

In 2023, when someone turns age 73, the IRS forces them take a required minimum distribution (RMD) from any traditional IRA or pre-tax qualified plan accounts, but Roth IRAs don’t fall under that umbrella. Roth IRAs already paid the income tax on the money when it into the account.

Is there an ideal time to convert a traditional IRA to a Roth IRA?

While no one has a crystal ball, it is better to do conversions during a down market. For example, if you have an account value of $100,000 and it drops to $90,000, it would be less of a tax burden to convert it while the market was down.

What other items should I consider before I make this move?

The main factor to consider for a backdoor Roth IRA is the tax burden. If you don’t have extra cash set aside to pay the taxes, then you should hold off on converting those dollars until another time. The last thing you should do is cash in any portion of your retirement accounts early (especially if you’re under age 59 ½) in order to pay a tax bill. If you’re under age 59 ½, the IRS will slap you with an early withdrawal penalty of 10 percent, in addition to the income tax you’ll already owe. This would do more harm than good, since you’re taking money from those accounts, rather than giving it an opportunity to compound and grow.

Navigating the nuances of where you should place your money, why you place it there and when you can access it can be tricky. If you’re unsure of where to start, consult a financial advisor for guidance!