Ep.710: How To Do A Backdoor Roth IRA Dads Daughters and Dollars

A "Backdoor Roth IRA" is not an account, it is a strategy used by high-income earners who can't contribute to a Roth IRA because their income is too high. Let’s quickly describe the difference BETWEEN a Roth IRA and a regular IRA. A Roth IRA is a tax free retirement account where you make a contribution to your Roth IRA account after you’ve already paid tax on it. So let’s say you get paid $1000 dollars a week and you take home $800 after they take out taxes. So you’ve paid TAXES. You decide to contribute $100 of your $800 take home pay to your Roth IRA every paycheck. Since you already paid tax on the $1000, you are allowed to contribute to a Roth IRA, let it grow tax free and when you retire, you get all of the contributions and all of the compound interest tax free. So that’s a Roth IRA. A Regular IRA is a taxable retirement account where you make a contribution to your Regular IRA account BEFORE you’ve paid taxes on it. So the same example-you get paid $1000 dollars a week and BEFORE any tax deductions are done you set up to have $100 sent to your Regular IRA. You get to take a tax deduction for the $100 contribution to the Regular IRA but when you retire your Regular IRA is taxable. So the difference is with the Roth IRA you pay taxes BEFORE the money goes in your account, with Regular IRA you pay taxes when you retire or take the money out of the account.  At the top of the show, I said is a Backdoor Roth IRA is a strategy used by high-income earners who can't contribute to a Roth IRA because their income is too high. What does their “income is too high" mean? As of 2023, if you’re single you can’t contribute to a Roth IRA and you make over $153,000 for single tax filers, and if you are married and file jointly, you can’t make more than $228,000. So high income earners thought how can we make a Roth IRA contribution EVEN though we make too much money. How? Well with the Roth IRA there are income limits to contribute. With a regular IRA,THERE ARE NO INCOME LIMITS. You could make 50 Million a year and still contribute to a regular IRA.  So the strategy became: let's contribute to a Regular IRA and then convert that to a Roth IRA.   

I said we’d talk about how to contribute to a Regular IRA and then convert that to a Roth IRA. I think the best description of how to do it is on the White Coat Investor website. Here is the link to a tutorial from the White Coat Investor of how to do the Backdoor Roth IRA. https://www.whitecoatinvestor.com/backdoor-roth-ira-tutorial/comment-page-10/ So these are the steps to do the Backdoor Roth IRA if you are above the income limits. You need 2 accounts . You need a Regular IRA account and you need a Roth IRA account. Ideally you have a Regular IRA account with no money in it.   OK. You have the 2 accounts at Schwab, Fidelity, Vanguard-whatever brokerage you use. You now make a non-deductible contribution to a Regular IRA. Meaning pay taxes on the weekly salary and then make a contribution from the take home pay. Let’s say you contribute the max for 2023 of $6500. Once you see the money in the Regular IRA and it is just cash because it hasn’t been invested yet, you transfer the full amount to your Roth IRA. Because the money was in your Regular IRA for 5 minutes before it was converted you don’t owe any taxes BECAUSE it didn’t earn any money in that 5 minutes it was in the account. You then would invest the $6500 that has been transferred to your Roth IRA. So why do you want 0 dollars in your Regular IRA? Because any money that is there is taxable once it comes out. And you need to convert any money that is in taxable retirement accounts. So we’ve never done a Backdoor Roth IRA. My wife and I both had IRA’s and SEP-IRA’s for 24 years before a Backdoor IRA became law in 2010. We would have paid a ton of tax to do a Backdoor IRA.