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How To Do A Backdoor Roth Thumbnail

How To Do A Backdoor Roth


[00:00:03] Hi, this is Antwone Harris with Platinum Bridge Wealth Strategies and Roth IRA counts are great. You put money in, it grows over time. You pull the money out tax free. What's not the like? When you pull money out of a 401K account or an IRA account, you have to pay income taxes, and this becomes a challenge, especially when you're retired.

[00:00:22] Now, we expect tax rates to go up in the future, so getting as much money in a Roth IRA account is a good thing. The challenge is many of my clients make too much money to contribute to a Roth IRA account. However, as is the American way, there's a loophole. For tax year 2023, if you're single and you make over $153,000, or if you're married filing jointly and you make over $228,000, you're not eligible to contribute to a Roth IRA count.

[00:00:54] There is something called a backdoor Roth, and here's how it works. It's a very simple process. You make a contribution to a traditional IRA account up to the limit for that year. So, for 2023, the limit is $6,500. If you're age 50 or over by the end of 2023, then you can add an additional thousand dollars.

[00:01:15] You then convert that money to a Roth account sometime in the same tax year. When you do a conversion, it's a taxable event. You're going to owe income taxes on that conversion. So in this example, if you contribute $6,500, you're going to owe taxes. Now the amount of taxes that, where it is, where it gets a little more complicated. So theoretically it'll be great if you could take after tax money that you've already paid taxes on, put it in a traditional IRA account and convert right away.

[00:01:45] There's been no growth, so theoretically, you would owe no taxes. But that's not how it works. There's something called the Prorata Rule, so that the IRS is able to earn some kind of tax revenue when you do this conversion.

[00:01:58] You're required to aggregate all of your IRA accounts. You total those up and the amount that is pre-taxed, whatever percentage that is, that's the amount that you're going to pay taxes on for this new contribution.

[00:02:13] Here's an example. We have a client with $93,500 in a rollover IRA account. They've recently added $6,500 in this example, to a traditional IRA account that they're going to plan to convert sometime in the near future. So now they have a hundred thousand dollars in total in IRA accounts when they're looking at everything in aggregate.

[00:02:36] The conversion process is very simple. They simply call their advisor. They call their broker. They say, "We want to do a Roth conversion." The people on the back end know exactly what to do. So we're converting $6,500 in this example, but now we have to calculate the amount of tax that we're going to owe.

[00:02:54] So we take this conversion of $6,500 and we divide it by the total amount in IRA accounts in this example, $100,000. That means that six and a half percent is tax free. That's $422-$422.50 dollars of this $6,500 contribution. The remaining amount- it's taxable. So they're going to owe tax on $6,077 and 50 cents, in this example. This way, the IRS is able to get their tax revenue. You have $6,500 that's been converted to this Roth IRA account. We can invest that money. We can invest it very aggressively. Hopefully we grow it over time. We're pulling out that money later in the future tax free.

[00:03:42] There are a few other considerations.

[00:03:44] First, you want to make sure that you can pay the taxes for this conversion with an account outside of the IRA account. You don't want to deplete the money in this Roth account to pay taxes. You want to be able to pay the taxes from an outside account. Two, be sure to file Form 8606 with the IRS when you do your taxes.

[00:04:02] That's going to account for the fact that you did a non-deductible IRA contribution, as well as the fact that you did a Roth conversion when you facilitate this transaction. Finally, if none of this works for you, take a look to see if you have access to a Roth 401k through your employer or through your business because there's no income limit to on a Roth 401k and it has the same impact; you're able to grow this money and pull this money out tax free.

[00:04:29] The conversion process can be a little complicated from a tax perspective. If you have any questions, feel free to reach out to me, your advisor, or your tax professional. This is Antwone Harris with Platinum Bridge Wealth Strategies and I'll talk to you soon.