Back Door

August 22, 2018 - Published by IAG Wealth Partners

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There are typically only two types of people that enter your house through the back door – family and friends or thieves.

In the new tax law, Congress clarified that assets entering a Roth IRA account through the back door are your friends.

Roth IRA accounts have some uniquely attractive features – primarily tax-free withdrawals in retirement and tax-free access to contributions before retirement. There are other benefits and restrictions on Roth IRAs, so please be sure to consult with your tax professional to see how they apply to your specific circumstances.

Unfortunately, taxpayers with higher earnings (over $199,000 modified Adjusted Gross Income in 2018 for married filing jointly) are not eligible to make contributions to Roth IRAs.

To get around this limit, some taxpayers use a “back door” to gain access to the benefits of Roth IRAs. They make a nondeductible IRA contribution to a traditional IRA account and then almost immediately convert that IRA account to a Roth IRA.

This “back door” strategy only works if a taxpayer has $0 in any IRA accounts before they make their nondeductible contribution. A taxpayer may have money in 401(k), 403(b), or 457 retirement accounts, but not in any IRA accounts.

Because the taxpayer’s new traditional IRA account only held money for which the taxpayer did not take a tax deduction, no (or very minimal) taxes are due when they convert the traditional IRA to a Roth IRA.

The end result is that a technically ineligible taxpayer made a Roth IRA contribution – which sounds shady at best. This “back door” strategy was never endorsed by Congress or the IRS, but it was also never challenged by them. Those that used the back door Roth IRA strategy did not know whether they would be viewed as thieves or friends.

Thankfully the new tax law makes it abundantly clear – those that enter a Roth IRA through the back door are not thieves, but friends.

If you are ineligible to make Roth IRA contributions, the back door is now open.


Quote of the week:   A.J. Cronin: “Life is no straight and easy corridor along which we travel free and unhampered, but a maze of passages, through which we must seek our way, lost and confused, now and again checked in a blind alley. But always, if we have faith, a door will open for us, not perhaps one that we ourselves would ever have thought of, but one that will ultimately prove good for us.”

Securities offered through LPL Financial. Member FINRA/SIPC. Investment advice offered through IAG Wealth Partners, LLC, (IAG) a registered investment advisor and separate entity from LPL Financial.

The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.

Any opinions are those of IAG and not necessarily those of LPL Financial. Expressions of opinion are as of this date and are subject to change without notice. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein.

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