There are numerous benefits to converting to a Roth IRA. Please remember, it is important to review all of your retirement accounts before converting to a Roth IRA. Some benefits of a Roth IRA include;
• Required minimum distributions are not obligatory until the participant’s death.
• Withdrawals are tax free.
• They pass onto your heirs income tax-free.
• You can compound your investments in a tax-free fashion.
Am I a Candidate for a Backdoor Roth IRA?
Backdoor Roth IRAs can be appropriate for investors who:
- Only have retirement account through their jobs (i.e. 401k’s) and want to increase their retirement savings in tax-advantaged accounts, but whose income is too high to qualify for standard Roth IRA contributions; and
- Have the time and ability to wait for five years or until they are 59 ½ to avoid the 10% penalty on early withdrawals. (If you open and make contributions to a Roth IRA in the standard manner, i.e. not through conversion, you are not subject to this rule).
A Backdoor Roth IRA is probably not recommended if you:
- Are over the age of 70½ and can no longer contribute to a traditional IRA.
- Don’t want to contribute more than the maximum retirement limit through your workplace retirement account.
- Already have money in a traditional IRA and because of the Pro Rata rule may end up in a non-tax advantageous position when converting to a Backdoor Roth IRA.
- Plan or expect to withdraw the funds in the Roth IRA within the first five years of opening it. A Backdoor Roth is considered a conversion and not a contribution. Therefore, the funds will incur a 10% penalty if withdrawn within five years unless you are age 59 ½ or older.
- Are in a high tax bracket now and expect to be in a lower tax bracket in the future.
- Plan to relocate to a lower- or no- income tax state.
Stay tuned for my next blog post, Recharacterizations and the Conclusion!
Disclaimer: Please note that the Tax Cuts and Jobs Act of 2017 removed the ability for taxpayers to do any “recharacterizations” of Roth IRA conversions after 12/31/2017. The material below was created and published prior the passage of the Tax Cuts and Jobs Act of 2017.
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– James Lange