As of tax year 2022, the ability to contribute to a Roth IRA begins phasing out at modified adjusted gross incomes (MAGI) of $204,000 for married couples who file joint returns, or $129,000 for single taxpayers. The limit for single taxpayers also applies to head-of-household filers and to married taxpayers who file separate returns, as long as they haven’t lived with their spouses at any point during the tax year. “Phasing out” means your contributions are somewhat limited if you pass the first threshold for your filing status. You can reach a point where you can’t make contributions at all when your income hits the second threshold. You’ll reach this point at an MAGI of $214,000 in 2022 if you’re married and filing a joint return, or $144,000 if you’re a single filer. But you can make contributions to a traditional IRA after you reach these income thresholds. You can then move your money into the Roth IRA account through the “back door.” You also can convert as much as you like because there’s no cap on these transactions, either. You could not make direct contributions to a Roth IRA in 2022 if you’re a single taxpayer with an MAGI of $145,000, for example. But you could contribute to your traditional IRA instead, then move the money from there into your Roth IRA in a second step. Your savings will ultimately end up exactly where you want them to be—in the Roth. You just have to take an extra step to get it there.
Why a Roth IRA?
Roth IRAs come with several benefits that other retirement savings plans don’t share, so simply saving to a traditional IRA instead isn’t the best solution for all earners. Earnings on money saved in a Roth are tax-free, as are withdrawals of contributions, because that money was already taxed in the year it went into the account. There’s no tax deduction available for Roth contributions in the way there is for contributions to traditional IRAs. Distributions from a traditional IRA are subject to income tax upon withdrawal if a deduction was claimed at the time the money was contributed. You can be hit with a 10% tax penalty if you take an early withdrawal from a traditional plan prior to age 59½, but that’s not the case with a Roth. You can take distributions penalty-free after you’ve held the account for five years. You don’t have to stop making contributions to a Roth plan when you reach age 70½ as you do with other plans. And you don’t have to take required minimum distributions (RMDs) from a Roth, either. RMDs are in place to force savers to start taking their money back at a certain age so the contributions can finally be taxed upon withdrawal, but they apply to plans that provide tax deductions for contributions.
How a Backdoor Roth IRA Works
Of course, rules apply to this backdoor strategy. You can’t claim a tax deduction for the initial contribution you make to your traditional IRA. The same income limits that prevent you from contributing directly to a Roth IRA would also bar you from claiming a tax deduction for the amounts put into a traditional IRA instead. Income limits apply to this tax perk as well.
The Effect of Pending Legislation
A backdoor Roth IRA may not continue to be a viable option for high-income taxpayers going forward. As of publication time in 2022, legislation was pending that could eliminate the provision of the tax code that allows this maneuver, effectively closing the back door. The House Ways and Means Committee issued a proposal in September 2021 that is included in the Biden administration’s Build Back Better Act. It aims to restrict tax breaks for wealthy individuals. One of its provisions would prohibit the conversion of non-deductible funds from traditional IRAs. Tax-deferred conversions would still be permitted, however.
What It Means for Individual Investors
A Roth IRA is a more beneficial way to save for retirement for numerous reasons, and the federal government knows that. Everyone might save with these plans if they could, but the government doesn’t realize significant revenue from Roth plans; thus, the income restrictions for direct contributions. A backdoor Roth IRA approach works most smoothly if you open your traditional IRA with the funds you intend to convert. The IRS will prorate your tax-free distributions if you convert from an established traditional IRA that contains both tax deductible and nondeductible contributions. Taxes on tax-deductible contributions as well as on their earnings come due in the year of conversion.
