What is a Backdoor Roth IRA?
If you already own a traditional IRA with pre-tax contributions, you should think about what it all means regarding the pro-rata rule before moving forward. The pro-rata rule is an IRS rule specifically regarding taxing IRA conversions when you have pre-tax and after-tax contributions in tax-advantaged accounts. This could lead to a substantial taxable event because you must pay taxes on the pre-tax amounts converted. The current guide, at the link you gave above and linked here, has all of the steps to enter the conversion.
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This essential form documents your non-deductible traditional IRA contribution and keeps track of the basis (after-tax money) in your IRA. There’s another reason why delaying your conversion after funding the traditional IRA can cause problems. Your funds will likely generate earnings during any waiting period, and these earnings become taxable upon conversion. The IRS uses the “IRA aggregation rule” to view all your IRAs as one entity when calculating conversion taxes. To cite an instance, imagine you have combined traditional IRAs worth $50,000.
The process for entering a backdoor Roth can be so much simpler. We are not CPA’s and the software is for consumers. The help or “learn more” articles within the desktop software when entering the backdoor conversion give even harder to understand explanations and content. Why can’t the program be more worded toward the consumer than the tax Pro?
Not like they just don’t have it anymore or that they simply can’t do it? High-income earners can sidestep the Roth IRA’s income restrictions through this strategy. The process involves making non-deductible contributions to a traditional IRA first and then converting those funds to a Roth IRA.
- If you don’t do it right, your numbers will probably not look right, with things like penalty charges for excess contributions showing up when they shouldn’t.
- This means that with each distribution/ conversion you will have a taxable and nontaxable part.
- No need to be stuck in a loop for ever looking up what this or that means when trying to input the info correctly.
Your Retirement Savings
- Smart investors need to watch the pro-rata rule’s impact.
- Since you made no traditional IRA contribution for 2024, there is no traditional IRA contribution to enter.
- Yes, you can perform a backdoor Roth IRA conversion annually.
- High-income earners who cannot otherwise directly contribute to a Roth IRA can enjoy the same long-term benefits of tax-free retirement growth and withdrawals by using a backdoor Roth IRA.
- At the end, you want to look at the Form(s) 8606 that Turbotax generates, just like you would check up on one filled out by an accountant.
- Backdoor Roth IRA strategies give high-income earners a great way to save for retirement with tax advantages.
This creates a path to tax-free growth and tax-free withdrawals during retirement. 1 – When you tell the program that you rolled over the money from the Traditional IRA to another retirement account, the amount is not taxable because it is going from one account to another similar account. When you indicate that the distribution was converted to a Roth IRA, then it is being calculated as taxable since a Traditional IRA with no basis (non-deductible contributions) is different from a Roth IRA. Once you have entered information about your basis in the Traditional IRA, then indicating that it was converted will not be taxable.
When you file your taxes, you report your conversion on Part II of Form 8606. First, you, as a high earner, get no IRA deduction despite contributing $6,000-$12,000 to IRAs for the year. Second, now that you’ve entered your conversion and contribution, the amount of tax due as calculated by Turbotax in the upper left (“Federal Refund $0”) hasn’t changed. That shows you that you did the whole process correctly. There should be no additional tax due from contributing to an IRA indirectly via the Backdoor Roth IRA process.
The lack of required minimum distributions (RMDs) makes Roth IRAs even better. Your investments can grow tax-free longer if you don’t need the money right away for retirement expenses. Using a backdoor Roth IRA strategy means converting traditional IRA contributions to a Roth IRA. You do not have to open a new Roth account to do so.
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The earlier you start saving for your retirement, the more you’ll have to work with once you’ve removed yourself from the workforce. But this can be a complicated process, which is why people use software like TurboTax to help them to keep track of their contributions and tax breaks. I don’t know all the mechanics unfortunately, you may need to recharacterize the conversion back to the IRA to unwind the 1099-R with the custodian/broker, then withdraw it from the IRA. Hopefully a CPA/Expert will respond here to provide guidance.
Action Steps
If you don’t do it right, your numbers will probably not look right, with things like penalty charges for excess contributions showing up when they shouldn’t. If you’re doing your Backdoor Roth IRA “correctly” in the “normal” way, your basis at the end of the prior year should be $0. If yours isn’t for some reason, put in your basis (i.e., non-deductible money put into the traditional IRA but not converted out of the IRA). Since you didn’t take the money out and buy a sailboat with it, click the first button. Since it was a Roth conversion, you click the second button in answer to the second question and hit continue.
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This gives high earners a way to get Roth benefits regardless of how much they make. While the process is simple, the IRS rules and tax ramifications mean you must act carefully. It is important to get it right because improperly reported conversions can lead to tax consequences and penalties. First question, after doing the steps above for wages… In the deductions section the first question TT asks is “check the boxes for kinds of IRAs each of us owns or will contribute to for 2024”.
The final step requires you to document this transaction on IRS Form 8606 with your tax return. This crucial paperwork proves your traditional IRA contribution was non-deductible and maintains your dollars’ after-tax status. You might pay extra taxes on the conversion without proper documentation. The form also shows the conversion itself, which completes your backdoor Roth IRA paper trail. Remember that spouses must each file their own Form 8606 if they both use this strategy. A backdoor Roth IRA isn’t just a retirement account—it’s a legal loophole that lets high-income earners contribute to a Roth IRA despite IRS income limits.
If your traditional IRA earns income before the conversion, you’ll owe taxes at your ordinary tax rate on that growth when you convert to a backdoor roth turbotax Roth. Converting quickly before your contributions grow ensures that all future growth happens tax-free in the Roth to maximize your long-term tax savings. Roth IRA income restrictions depend on an investor’s modified adjusted gross income and tax filing status.
You can build tax-free retirement savings without worrying about income restrictions. High-income individuals turn to this strategy because their earnings exceed the income limits for direct Roth IRA contributions. The 2025 limits will go up to $165,000 for singles and $246,000 for joint filers. High-income earners who cannot otherwise directly contribute to a Roth IRA can enjoy the same long-term benefits of tax-free retirement growth and withdrawals by using a backdoor Roth IRA. A workaround for the pro-rata rule involves rolling pre-tax contributions to your traditional IRA into your company-sponsored 401(k) before converting after-tax balances to a Roth. Start by opening a traditional IRA account through any brokerage firm, financial institution, or even robo-advisor.
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Once there, you can click on your Form(s) 8606 to make sure you did it right. This question is asking about recharacterizations, discussed above. If you’re doing your Backdoor Roth IRA correctly, you’ll answer this one “no” to go to the next page.
Backdoor Roth IRAs provide no up-front tax benefits but offer tax-free growth and withdrawals in retirement. After your contributions hit your traditional IRA, you can convert them to a Roth IRA. Converting is another word for moving money from the traditional retirement account to the Roth.
However, contributions can be withdrawn at any time without penalty. The biggest difference shows up in how you get money into the account. Regular Roth IRA holders can contribute directly if their income falls below the limits. The backdoor approach needs two steps – first putting money in a traditional IRA, then converting it to a Roth IRA. Once you’ve followed these steps, you should have successfully entered the information the software needs to properly calculate your tax return.
There was no compensation paid to the client for this testimonial. A client testimonial does not guarantee future investment success and should not be indicative that any client or prospective client will experience the same or a higher level of investment performance. Foundations Investment Advisors, LLC is an SEC registered investment adviser. Past performance is not indicative of future results. Financial experts suggest completing the conversion within days of the original contribution to minimize tax effects.