Consider a Backdoor Roth IRA

by Lewis A. Weinstein
Founder and CEO of GenerationTax

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TOP MBA TAX STRATEGIES

Consider a Roth IRA Conversion During Your Low Income Years

Consider Amending Your Tax Return to Deduct your MBA as a Work Related Expense

Consider Withdrawing Funds From Your IRA–Penalty Free

Consider Recognizing Long- Term Capital Gains in Low Income Years

If your income in 2018 is more than $135,000 ($199,000 if married filing joint) you’re not eligible to make a regular 2018 Roth IRA contribution. Your only option therefore is to make a contribution to a non-deductible traditional IRA. However, you could then subsequently convert your 2018 traditional IRA contribution into a Roth IRA (aka:  backdoor Roth IRA) and pay no taxes on the conversion since your tax basis (i.e. the amount of your contribution) is equal to the amount you converted. It’s a nice little work around that enables you to accomplish your goal of a funding a Roth IRA.

How is a Roth IRA different from a Traditional (regular) IRA?

The main difference between the two types of IRAs is when you pay taxes on your investments. Traditional IRAs can delay the taxes until retirement, but with Roth IRAs, you pay tax now rather than later.

Here's how it works: With a Roth IRA, there is no up-front tax break, but you don't have to pay tax on withdrawals in retirement. That's the opposite of a traditional IRA, which may allow you to deduct at least part of your contributions if you qualify, but requires you to pay income tax on money you withdraw in retirement. Both accounts allow investments within them to grow without getting clipped by taxes each year.

There are other differences too. Roth IRAs offer a bit more flexibility than traditional IRAs do. You may withdraw your contributions to a Roth IRA penalty-free at any time for any reason (but you'll be penalized for withdrawing any investment earnings before age 59 ½ unless it's for a qualifying reason). If you withdraw funds from your Roth IRA to pay for your college tuition, course materials and room & board you will not be subject to the 10% penalty. If you converted money from a traditional IRA into a Roth IRA, you can't take it out penalty-free until at least five years after the conversion unless it's for a qualifying reason such as college expenses.

Roth IRAs also let you leave your money untouched for as long as you like. With a traditional IRA, you must start making withdrawals called "required minimum distributions" after you reach age 70 ½. And while you can no longer make contributions to a traditional IRA after you have turned 70 ½, you can keep contributing to a Roth IRA regardless of your age.