The backdoor Roth
The strategy allows higher earners to sidestep the earnings limits for Roth individual retirement account contributions, capped at $144,000 modified adjusted gross income for single investors and $214,000 for married couples filing together in 2022.
On April 5, you could convert your traditional IRA to a Roth IRA. However, the conversion can't be reported on your 2021 taxes. Because IRA conversions are only reported during the calendar year, you should report it in 2022.
What may happen, and it's something to prepare for now, is that in 2023 converting after-tax money will be prohibited. As of right now, backdoor Roth IRA contributions are still permitted. Typically, it's in the investor's best interest to make these backdoor contributions while they still can.
As of March 2022, the Backdoor Roth IRA is still alive. Therefore, any taxpayer making more than $214,000 in income and is married and filing jointly can make an after-tax Traditional IRA contribution and then potentially do a tax-free Roth IRA conversion.
Contribution rules
Meaning, you can fund your 2022 IRA at any time between Jan. 1, 2022, and the tax filing deadline in 2023. You may contribute to a traditional IRA or Roth IRA whether or not you participate in a retirement plan through your job, such as a 401(k).
Historically low tax rates make 2021 a great time to convert your traditional IRA to a Roth account. "It's the best time in history to convert to a Roth," says Elijah Kovar, co-founder of Great Waters Financial in Minneapolis. "Between now and 2025, the last year of tax reform, taxes are on sale."
Disadvantages of a Roth IRA Conversion
Of course, when you do a Roth IRA conversion, you risk paying that big tax bill now when you might be in a lower tax bracket later. While you can make some educated guesses, there's no way to know for sure what tax rates (and your income) will be in the future.
The Roth IRA program is growing rapidly, making ever-larger contributions to the nation's economy. We can rest assured the government has no interest in ending the program, which is exactly what would happen if withdrawals were made taxable.
But even when you're close to retirement or already in retirement, opening this special retirement savings vehicle can still make sense under some circumstances. There is no age limit to open a Roth IRA, but there are income and contribution limits that investors should be aware of before funding one.
Bottom Line. If you want to do a Roth IRA conversion without losing money to income taxes, you should first try to do it by rolling your existing IRA accounts into your employer 401(k) plan, then converting non-deductible IRA contributions going forward.
If you're approaching retirement or need your IRA money to live on, it's unwise to convert to a Roth. Because you are paying taxes on your funds, converting to a Roth costs money. It takes a certain number of years before the money you pay upfront is justified by the tax savings.
Whether you are 80—or 20, or 50, or 90—your age should not dictate whether or not you make a Roth conversion.
The year you do a Roth conversion, your taxable income will rise, which could cause a portion of your Social Security benefit to be taxed or push you into a situation where more of your benefit is taxed.
Financial planners say the changes make Roth conversions more attractive for big savers — typically those with $1 million or more in their retirement accounts — who want to reduce future tax bills for themselves or their heirs.
Another reason is that a backdoor Roth contribution can mean significant tax savings over the decades because Roth IRA distributions, unlike traditional IRA distributions, are not taxable.
How Much Tax Will You Owe on a Roth IRA Conversion? Say you're in the 22% tax bracket and convert $20,000. Your income for the tax year will increase by $20,000. Assuming that this doesn't push you into a higher tax bracket, you'll owe $4,400 in taxes on the conversion.
Individual IRA and Roth IRA accounts offer another way to save for retirement. Your total contributions to traditional or Roth IRAs are limited to $6,000 in 2022—the same as in 2021. Taxpayers who are 50 and older can make an additional $1,000 catch-up contribution.
2021 Traditional & Roth IRA Contribution Deadline is 4/15/2022.
Is there a deadline to convert? Yes, the deadline is December 31 of the current year. A conversion of after-tax amounts is not included in gross income. Any before-tax portion converted will be included in your gross income for the conversion tax year.
The government only allows you to contribute $6,000 directly to a Roth IRA in 2021 and 2022 or $7,000 if you're 50 or older, but there is no limit on how much you can convert from tax-deferred savings to your Roth IRA in a single year.
A Roth conversion may push your taxable income high enough to cause an income-adjusted surcharge in Medicare premiums. For example: A married couple with $100,000 of income would be paying the lowest Medicare rates of $170.10 (2022) for Part B and $0 for Part D.
Remember, if you're already over 72, you will have to take an RMD for the current tax year before you can convert to a Roth IRA—that is, Roth conversions do not satisfy the RMD requirement, although you can use all or part of the RMD to pay the taxes due from the conversion.
Backdoor Roth IRA Pitfall #2: The 5-Year Rule
There's just one limit on this feature: You have to wait five years after making your first contribution to avoid taxes when taking withdrawals from the account. The five-year clock starts ticking on January 1 of the year you made your first contribution.