Having a Roth retirement account enables your money to grow tax-free. You also will not be required to take required minimum distributions (RMDs) when you reach 73 and do not need to pay taxes on the money when you make a withdrawal. Contributing through a backdoor Roth individual retirement account (IRA) enables you to reduce taxes and skip the requirement for taking RMDs.
Contributions to a traditional IRA are tax-deductible. Because you get a tax break with your contributions, you will pay taxes when you withdraw money at your regular income tax rate.
Tax-Free Withdrawals From Roth Accounts
Getting a tax-free withdrawal from your Roth account has two requirements. You must be at least 59½, and the account must have been open for at least five years. When withdrawals are made that do not meet these requirements, you will need to pay taxes on the amount withdrawn, and there will be a 10 percent penalty.Income Limits on Contributions
People who are married and filing jointly and earn more than $143,000 in 2024, the Fool says they cannot contribute to a traditional IRA and get a tax deduction. Singles cannot contribute more than $77,000. If an employer’s retirement plan covers your spouse, a married couple filing jointly cannot make any contributions once their combined income exceeds $240,000.The Backdoor Roth Option
You can still contribute to a regular IRA even if you earn more than the income limit. When you do, you will not get a deduction for it.The Pro Rata Rule for Conversions
Vanguard states that some IRAs require the application of a pro-rata rule when making a conversion. When present, this rule will vary, but it may state that a conversion consists of 90 percent pre-tax money and 10 percent after-tax money. Taxes will be required on any earnings.Another Five-Year Rule
Even though the five-year rule was mentioned already, a second five-year rule applies to backdoor Roth conversions. Forbes mentions that each time you make a backdoor Roth conversion, you will need to wait five years before you can withdraw it without a penalty. The rule applies to each conversion you make.Contribution Limits for Roth IRAs
The IRS says the 2024 contribution limit to an IRA is $7,000. People 50 and older are allowed to contribute an extra $1,000.A big advantage of making a backdoor Roth IRA conversion is that the money is treated differently than when you contribute to a traditional IRA. Investopedia says that the IRS does not consider a backdoor conversion a contribution. It enables you to roll over as much as you want to a Roth account, and there are no income limits or contribution limits on rollovers.
When you properly do the backdoor Roth conversion, you will owe taxes on the amount you roll over. No taxes will need to be paid on money already taxed. Your account administrator must automatically send the money directly to the new account. If you cash it out and do not redeposit it within 60 days, you will pay taxes on all of it. Once in the account, you will not owe taxes on the growth.
You can make a backdoor Roth IRA conversion the day after depositing it. It is not necessary to wait. If you wait, you will also owe taxes on any growth the money receives. For more details, talk to your account manager to be sure you make no mistakes.