IRA Contribution Limits: Should You Convert to a Backdoor Roth IRA?

It’s extremely important that you take your retirement into your own hands. The concept of a government-sponsored retirement is not the best plan. The developed world's population is continuing to age, with fewer and fewer working-age people remaining to contribute to social security systems.

On a more positive note, your retirement savings can not only help you, but it can also potentially help family and loved ones. Some people use retirement savings to help family members by contributing to their children or grandchildren's lives. Examples include: financing an educational expense, passing on assets to loved ones or simply keeping legacy assets, such as land or real estate, within the family. If you can't contribute to a Roth IRA, here's why a Backdoor Roth IRA may be a sensible option for you.

2017 IRS Contribution Limits for Retirement Plans

The chart shows the IRS changes for 2017, including income limits for those who contribute to both a traditional IRA and a workplace retirement plan (or those whose spouses have access to a workplace plan), as well as the income limits for those who contribute to Roth IRAs.

2017 IRS Limits for Retirement Plans Chart

Why You Need a Roth IRA

For those who qualify, a Roth IRA can be a very advantageous retirement planning tool. Roth IRAs allow you to grow your money tax-free. You can also withdraw your contributions at any time, both tax-free and penalty-free. Roth IRAs have rules and limitations; however, Roth IRAs may improve your tax picture but not everyone can contribute to a Roth IRA.

There are income limitations on who can contribute to a Roth IRA. In 2017, eligibility to contribute to a Roth IRA for single filers in 2017 starts to phase out at $118,000 and completely phases out at $133,000.

Backdoor Roth IRA: Strategy for High-Income Earners to Participate in Roth IRAs

The traditional contribution ("front door") for Roth IRAs is currently not available for higher income earners, specifically married couples earning $196,000 or more and singles earning $133,000 or more as of 2017.

In 2010, Congress changed the rules and since then anyone can convert a traditional IRA to a Roth IRA. However, higher income earners are still ineligible to contribute to a Roth IRA.

A “Backdoor” Roth IRA is a strategy for high-income earners to put money into a traditional IRA and then roll that into a Roth IRA while reaping all of the benefits.

While this strategy sounds simple, there are several rules that you must know and follow to make sure you do not incur unintended tax consequences. Speaking with a certified financial planner or tax planner can provide some great guidance and value.

Beware of the Pro-Rata Rule for Roth Conversion

The pro-rata rule for Roth IRA conversions states that if you have any other deductible IRAs (i.e. a previous 401k that you’ve rolled over), the conversion of any contributions becomes a taxable event that you’ll need to pay taxes on upfront.

You want to be clear with your financial planner as to whether or not you have any other IRAs. Please also remember that your spouse’s IRA is separate from yours.

Set Up a Backdoor Roth IRA with Chatterton & Associates

A Backdoor Roth IRA is a strategy that can be useful for the right investor. However, they come with their limitations and complications and are not for everybody. There are precautions that need to be taken to reap the full benefits of any financial decision.

To find out if you are a candidate for a backdoor Roth IRA, contact Chatterton & Associates to discover the retirement strategy that’s right for you.

This article is for informational purposes only. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. For specific advice about your situation, please consult with a lawyer or financial professional. You should discuss any tax or legal matters with the appropriate professional.