Wealth Builders - A StatonWalsh Podcast

What is a Backdoor Roth IRA?

February 27, 2022 StatonWalsh Episode 9
Wealth Builders - A StatonWalsh Podcast
What is a Backdoor Roth IRA?
Show Notes Transcript

In this episode we will be discussing Backdoor Roth IRA contributions. This is a topic that has received a lot of press recently with talks of this strategy not being allowed in the future. We will breakdown exactly what a Roth IRA is and more importantly who is eligible for a backdoor contribution. As promised in the episode, click below for your guide on if a Backdoor Roth contribution would work for you. If you have questions about this topic, click the meet with us link below.

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This podcast is for informational purposes only. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice. StatonWalsh and Founder’s Financial Securities do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation.

Ryan Staton is an Investment Advisor of, and securities offered through, Founders Financial Securities, LLCMember FINRA/SIPC and Registered Investment Advisor.

Devin Walsh  is an Investment Advisor of, and securities offered through, Founders Financial Securities, LLCMember FINRA/SIPC and Registered Investment Advisor.

Check the background of this firm on http://brokercheck.finra.org/

Speaker 1:

Hello everyone. Thank you for listening in to today's episode of wealth builders presented by StatonWalsh. In today's episode, we're gonna discuss a topic of backdoor Roth, IRA contributions. For many of you out there, you may or may not know what a backdoor Roth IRA contribution is. This is a topic that's gotten a lot of press recently with some proposed legislative changes at a high level. In today's episode, we're gonna break down what exactly a Roth IRA is. And more importantly, what is a backdoor Roth IRA contribution, and ultimately who's gonna be eligible for that strategy over the course of today, we're gonna have a conversation about different moving parts and different questions that you should ask yourself. As you go into 2022 to figure out if a backdoor Roth IRA contribution is actually something for you.

Speaker 2:

This is wealth builders presented by StatonWalsh, a show designed to pull back the curtain of the financial industry and bring true transparency to the forefront of conversation. On the show. We cover topics like financial education, current events, and interview business leaders and industry experts with the ultimate goal of helping listeners discover their own path to financial independence.

Speaker 3:

So Ryan, we are back wealth builders . It took a little break there, but so excited to be back and talking about backdoor Roth, IRA contributions today, there's been a lot in the news lives . Talk about possibly canceling them . So , um, let's just get right into it. I'll kind of turn over to you and what your thoughts about everything with people talking about backdoor, all IRA contributions being eligible for them and , um, the possibility of them not being around the future.

Speaker 1:

Yeah. Well, first of all, happy to be back on the podcast. Train took a little bit of a hiatus there for a lot of reasons in life. My wife and I had our first children. So that was part of the reason twin boys . So that is certainly a hand, but now we're back to exciting topics like backdoor Roth, IRA contributions. So yeah, to your point, so many people may or may not be aware of what a backdoor Roth IRA contribution even is. I think a lot of people have gotten exposure to it more recently with some of the build back better legislation that happened in the fall of 2021. There were some other things buried in there. There was obviously some social and climate legislative changes, but also financially related. So one of the provisions that were included in that proposed legislation, which has yet to pass, so it's still available, but was taking away that idea of a backdoor Roth contribution. So at a high level just started from the top a Roth IRA in general. What is that? So a Roth IRA, the Roth provision is basically just a section of the tax code. What it says is you can make after tax . So think net pay of your paycheck. What you see deposited into your bank account. After tax funds placed into an IRA, an individual retirement account that then can be invested and that can grow over time. And once you get to whatever age you decide to retire, when you take that money out, that's considered tax free income to you. So the idea is you're already paying the tax up front on the money, and now you don't have to worry about doing that anymore. When you get into your later years of retirement, there's a lot of different reasons why people would do that, but what we can get into some of the other mechanics, but a backdoor Roth contribution, again, 30,000 foot view is really just looking at ways to get money into one of those tax free accounts, a Roth account when you may not normally have the ability to do so. So one of the kickers with a Roth IRA is that there are income limitations. What does that mean? If you make too much money, the IRS is not gonna allow you to contribute directly into a Roth IRA. So there are actually parts of the , there's a strategy built into the tax code, where you could make contributions to another type of an IRA, and then convert that money over into Roth. You'll end up still paying the same tax on that money potentially, but it's a little bit of multistep process. Let's just call it that there's moving parts to it. So it from a 30,000 foot view, all backdoor means is another way to get money into one of those Roth IRA accounts so that you can have some tax free money as part of your retirement portfolio.

Speaker 3:

Sounds like a great strategy, especially if your , um , modified adjust gross income is above that limit. But it sounds like there are a few steps . Do you think people are really utilizing this and taking advantage of this? Cause it sounds like it's such a great opportunity for someone who is making more to pay their taxes today rather than they're in the future.

Speaker 1:

Yeah. So there's a couple different things that come into play when you're considering this. I mean, one, I think just to start off the top, the question is, is the extra work worth the it to you? I think where investors have to look at this strategy and , and really think about, does this make sense? Is do I want to go through the steps of opening one account, putting money there, then moving it to another account. And then now I have these multiple account registrations open. So I think administration is one thing working with professionals, definitely helpful in that process. If you're trying to do it on your own, might get a little overwhelming or confusing, but it can be a good strategy depending on circumstances. But that's number one. I think number two, there's also moving parts with total contributions to retirement accounts in general. So there's something called an aggregate rule . And every year you only have a certain amount of contribution that you can make to retirement accounts in general. And so there's some calculation that goes into it. You have to be tactical in nature if you wanna say that, but there are ways to get money into these types of accounts. It's just, you have to kind of shuffle the puzzle pieces together and that's where it gets complicated. So there are people out there that do it that do it effectively that have been doing it for a really long time. And there are others that maybe haven't or one for a couple different reasons. One, they didn't know it existed or two, maybe they've explored it in the past. And they just felt like, you know what? This is a little too complicated for my liking. I think I'm just gonna stick with it. And then to piggyback off of that, the introduction of Roth 401k , which I think will be a topic, another episode that will kind of break that down even further. But the introduction to being able to make Roth contributions in your retirement account at work is another thing that it's changed, not necessarily changed the perception, but I think change the level of adoption that people are taking with backdoor Roth contributions.

Speaker 3:

So you're saying with the , so now if people don't wanna use the backdoor Roth and kind of go through the process, there are availabilities now in 401ks that their employers have their Roth four OHK . I know we would definitely do an episode on that. We're go deeper into that. Cause that's one of the biggest questions we get. Everybody wants tax free money and some of the higher earns out there . I wanna utilize strategies like this. So with this episode, if anybody who's listened to today , we'll have a link out there where there's a great worksheet that kind of takes you through the exact steps to do this backdoor Roth contribution. I do wanna talk about it a little bit further. So kind of the process for the Ryan . So obviously the first thing you gotta do is you gotta open a traditional IRA, right? Correct.

Speaker 1:

Yeah.

Speaker 3:

You gotta open that traditional IRA, then we gotta make the non-deductible IRA contribution. So you actually make the $6,000 , which is limit this year 7,000 or eight 50 or over you make that contribution into the non non deductible IRA. So how long do you have to keep that in there where you can kind of convert ? Is there any limits there or what's the next steps after that?

Speaker 1:

Yeah, so there's something called this step transaction doctrine. So when we get into that, it basically, there's not necessarily a boiler plate period of time. What I would say is that you wanna be mindful of not doing it too quickly. So the interesting thing, and this is just, I think, par for the course, when we talk about tax code and dealing with the IRS is that there are always going to be loopholes in the tax code, but they know that these loopholes exist and they, to some degree you can take advantage of them, but at the same time, they don't want you abuse using it to an extent . And that's why it's been introduced to leg potential legislation to get rid of it. But when we're talking about the step transaction doctrine, you really just wanna make sure that you are defining and period of time can vary. But you're basically defining this as a , a non deductible, traditional IRA contribution, like you mentioned, and what you don't want to do is put it into that account and then immediately convert it cuz then you, you would essentially violate that rule and that would open you up to scrutiny potentially in an audit, for example. So what the IRS wants to see in air quotes is that your initial intention is not actually to do a backdoor Roth contribution. It's actually to put money into a traditional IRA. And then the conversion is just something you decide to do later. So unfortunately there's not a boiler plate. I'll say like a boiler plate starting point where we say , you know, that's three months, six months, I think ultimately it comes down to making sure that one, you put it into the traditional account first and then you need to make a determination of how that money's gonna be invested is some or all of it gonna be invested. And then from there you're gonna wanna later convert that into the Roth IRA. So this is where professional guidance certainly can play a part. It can be tricky to figure that out what most people do with backdoor Roth contributions, just to be completely honest is they put the money in and they immediately convert it. It's not necessarily to say that that is the wrong way to do it. I mean, those steps are the right steps, but you want some time to pass in , in between each individual step. So ultimately you can make the case that, look, this wasn't necessarily my original intention, but it is something that I'm gonna do. And it sounds counterintuitive a little bit, but that's just kind of the way the rule is written and how it's viewed in the eyes of the IRS. Even though they know it exists and people do it all the time.

Speaker 3:

That's great info. Well, I feel we could talk about this for a much longer, but if anybody others listen, say, we really appreciate you listening. We're excited about getting back up and going with wealth builders and bringing a lot more great topics that are relevant to your life , um , to your business financially and whoever that may be. So make sure you click below, we'll have some information about this worksheet. You can download that for yourselves and look forward to the next episode. Thanks, Ryan .

Speaker 1:

Awesome. Yeah. Thanks.