If your federal income tax bracket is 32% or higher, doing a Backdoor Roth IRA is a terrible, terrible idea. It is highly unlikely you will be making more money, and thereby being in a higher tax bracket in retirement! It's nice to have tax-free money you can withdraw from in retirement.
Why create a backdoor Roth IRA? If you earn too much money to open a Roth IRA, you may still want to do so for the tax advantage of eventually being able to withdraw funds without paying taxes on the distribution. This is particularly useful if you expect to be in a higher tax bracket in the future.
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.
You can make backdoor Roth IRA contributions each year. Keep an eye on the annual contribution limits. If your annual contribution limit is $6,000, that's the most you can put into all of your IRA accounts. You might put the entire amount into your backdoor Roth.
The backdoor Roth IRA strategy is still currently viable, but that may change at any time in 2022. Under the provisions of the Build Back Better bill, which passed the House of Representatives in 2021, high-income taxpayers would be prevented from making Roth conversions.
Backdoor and mega backdoor Roth
In a backdoor Roth, investors make a non-deductible contribution to a traditional IRA and then quickly convert to a Roth IRA. Once the money is in a Roth IRA, it's tax-free when taken out (if you meet the holding period and age requirements).
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.
There are no income or contribution limits — that is, anyone can convert any amount of money from a traditional to a Roth IRA.
Again, backdoor Roth IRA contributions are considered taxable income. Kicking in too much could inadvertently push you into a higher tax bracket and trigger a hefty bill when you file your next tax return.
Roth IRA contributions are done with after-tax funds, meaning the income taxes were likely withheld from your paycheck. But if you're completing a backdoor Roth IRA, you'll pay income taxes on the funds at the time of the conversion.
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.
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.
While the legislation has not become law, the Build Back Better Act was set to eliminate the backdoor Roth IRA strategy as of Jan. 1, 2022.
Like the Backdoor Roth IRA, the “Mega” Backdoor Roth also got a reprieve in 2021, but its future is uncertain. The Mega Backdoor Roth is a 401(k) plan version of the Backdoor Roth IRA. It only works if your 401(k) plan allows for after-tax contributions and in-service distributions of after-tax funds.
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.
To create a backdoor Roth, deposit the maximum amount permitted in a traditional IRA. Since these monies are taxed (you are prohibited from contributing to a traditional IRA tax free), the backdoor Roth is completed by immediately converting the traditional IRA into a tax-free Roth IRA (hence, the backdoor!)
Roth IRA Early Withdrawal Penalty & Converted Amounts
If you withdraw contributions before the five-year period is over, you might have to pay a 10% Roth IRA early withdrawal penalty. This is a penalty on the entire distribution. You usually pay the 10% penalty on the amount you converted.
A mega backdoor Roth 401(k) conversion is a tax-shelter strategy available to employees whose employer-sponsored 401(k) retirement plans allow them to make substantial after-tax contributions in addition to their pretax deferrals and to transfer their contributions to an employer-designated Roth 401(k).
There is no prescribed age to open a Roth IRA. You can open it whenever you want. Since there is no Roth IRA age limit, you can consider opening an IRA after age 60 too. If you are wondering how long you can contribute to a Roth IRA, the answer is as long as you want.
You can have more than one Roth IRA, and you can open more than one Roth IRA at any time. There is no limit to the number of Roth IRA accounts you can have. However, no matter how many Roth IRAs you have, your total contributions cannot exceed the limits set by the government.
The Roth IRA five-year rule says you cannot withdraw earnings tax-free until it's been at least five years since you first contributed to a Roth IRA account. This five-year rule applies to everyone who contributes to a Roth IRA, whether they're 59 ½ or 105 years old.