Tuesday, March 27, 2012

Roth IRA Backdoor

First of all, having "backdoor" in the title of this post may have not been the best idea.  I'm worried about the type of Google search results this post may end up in. Secondly, yes, I'm writing ANOTHER article about Roth IRAs.  What can I say, if you aren't utilizing them you're missing out.  I can't stress that enough. Also, I'm writing this now because you can still fund an account using 2011 money if you're reading this before April 15.

That being said, this isn't an article where I'm going to keep harping on why you should be funding a Roth.  This article is specifically for those poor souls who make too much money to contribute to a Roth.  There is a catch 22 for IRA's, those who have enough money to max out their contribution aren't allowed to do so due to income limits.

The following is the 2011 and 2012 income limits for Roth IRAs.  To sum it up, if you are single and your modified gross income (MAGI) for 2011 is more than $122,000 you cannot contribute to a Roth.  If your married and your combined MAGI is greater than $179,000 you cannot contribute to a Roth.

But here's the good news.  There is a legal way to contribute to a Roth no matter what you've earned.  There used to be a rule that you could only convert a Traditional IRA to a Roth if your current MAGI was under $100,000.  In 2010 the government removed this income limit so that anyone could convert a Traditional IRA to a Roth. They did this in order to generate more tax revenue on the conversion.  This also opened up the backdoor that high-income earners can use to fund a Roth.  (Please note, as of this writing this option is available for 2011 and 2012.  The conversion income limit could be reinstated for 2013.)
  1. If you don't have a Roth IRA account, open one with a site like Sharebuilder.   It's an easy process that doesn't take very long.
  2. Open a Traditional IRA with the same brokerage you have your Roth IRA account.
  3. Fund your newly opened Traditional IRA with nondeductible money.  Typically contributions to a Traditional IRA can be written off of your taxes for that year, but we are contributing after tax money that is not written off.  
  4. Immediately convert your Traditional IRA to your Roth IRA.
  5. And boom goes the dynamite!  You just stuck it to the government.
PLEASE BE AWARE!  If you have an existing Traditional IRA that you have previously funded you will likely owe taxes if you convert it to a Roth IRA.  The above example assumes you are opening your first Traditional IRA, funding it with after-tax money and immediately rolling it over into a Roth.  If you have an existing Traditional IRA that you wish to convert to a Roth you absolutely should consult with a tax professional before rolling it over.

So there you go wealthy people, enjoy.  Feel free to email me if you'd like to send me some cash for showing you this powerful little loophole! 

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