IRA expert Ed Slott explains the workaround for high-earners who are otherwise shut out of direct Roth IRA contributions.
Direct Roth IRA Contributions: Backdoor Conversions Alive And Well
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Hi I'm Christine Benz from running star dot com. Eight years after their arrival Backdoor Roth IRAs are alive and well. Joining me to discuss the maneuver is Ira expert Ed slot. He's author of the newly revised retirement decisions guy. And thank you so much for being here. Great to be back here in Chicago. We're thrilled to have you in the studio. One topic that comes up a lot with our readers and viewers on Morningstar dot com is this idea of the Backdoor Roth IRA. Let's talk about who should consider using the backdoor IRA backed or Roth IRA manouver and really who doesn't have to consider it.
It's exactly as you say it's a maneuver it's a made up term Backdoor Roth IRA. But here's the situation. It's a way to get money into a Roth IRA when you otherwise wouldn't qualify. Now just to be clear there's two ways to get money into a Roth IRA. The big money is in the conversions. You can convert a billion dollars I mean if you have the money right and there's no income limits on that. But if you want to put 50 500 in a Roth IRA as a contribution then we're going to lower the bar. Then we want limits. This is out of control. Nobody knows why. Why do they have limits on such smaller amounts compared to the larger conversions. But that's where we are. So we're not talking about conversions which are unlimited anybody can do those. We're talking about the fifty five hundred dollars a year Roth IRA contributions or sixty five hundred if you're 50 or over. They do have income limits. OK. Nobody knows the reason. But they have limits. So it's not available to higher income taxpayers. The limits are relatively high for most people but there's a lot of people watching now that are over those limits would like to make a Roth contribution. So what developed over time has become known as a backdoor Roth or a work arounds and nobody liked that term especially with just finding out now people at IRS never like those terms there was a spokesperson that just came out recently and said that was the only problem we had. We just didn't like the name sounded a little better like that. So here's how it works. You start with a traditional IRA. Why. Because unlike a Roth IRA contribution that has income limit. There are no income limits for who can contribute to a traditional IRA. Now I'll just stop there because some people will say no no there are income limitlessly right. That's only for deductability if you have a few are active in a company plan. But there are no income limits for who can contribute just may end up with a non deductible IRA. That's all. So. So the process starts with a contribution to a nondeductible IRA for which there were no limits you could make a million dollars a year. And you can contribute fifty five hundred and then you convert it to a Roth. Now you're right back where you wanted to be you have the same fifty five hundred sixty five hundred in a Roth IRA even though you're over the limit. Now there was a lot of chatter about this over the years so that's illegal. You know you're getting to a place where the law says you're not allowed to be. People called it a step transaction and other legal things you have to worry about any of that anymore I'm not even going to get into that. I was never in that camp by the way. I always thought it was fine but now under the new tax law which this is not in the new tax law. But in the congressional conference report this is backdoor Roth not mentioned by name but the actual procedure or the mechanism is mentioned four times four times they say they state explicitly that this is allowable they say you can make a contribution to a traditional nondeductible IRA and convert it to a Roth. IRS came out recently and said well if Congress says it's OK we're good with it we won't challenge it.