Backdoor Roth IRA Conversion
Updated September 16, 2021

What Is the Backdoor Roth IRA Loophole and Do I Need to Use It?

Personal Taxes

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Roth IRAs are an incredible wealth-building tool.

They allow you to grow wealth tax-free for many, many years.

But there is a catch, and it’s one that catches many young people with burgeoning careers unaware.

If you make “too much” money, you can’t directly contribute to a Roth IRA.

But there is a solution…read until the end of the article to see what it is.

How Much Is Too Much for a Roth?

For 2021, if you make more than $140,000 as a single filer or more than $208,000 as married filers, you cannot contribute directly to a Roth IRA.

This amount essentially includes all the money you make during the year, including income from salaries and wages, net income from rental properties, and net self-employment income.

If you make more than these amounts and still directly contribute to a Roth IRA, the IRS will penalize you.

Roth IRA Income Limits 2021 and How to Get Around Them

This table shows whether your contribution to a Roth IRA is affected by the amount of your modified AGI as computed for Roth IRA purpose.  Don’t worry too much.

Investment Platforms
If your filing status is...
And your modified AGI is...
Then you can contribute...
married filing jointly or qualifying widow(er)• < $198,000
• > $198,000 but < $208,000
• > $208,000
• < 50: $6,000 50+: $7,000
• reduced amount
• zero
married filing separately and you lived with your spouse at any time during the year• < $10,000
• > $10,000
• reduced amount
• zero
single, head of household, or married filing separately and you did not live with your spouse at any time during the year• < $125,000
• > $125,000 but < $140,000
• > $140,000
• < 50: $6,000 50+: $7,000
• reduced amount
• zero
 

Amount of your reduced Roth IRA contribution

If the amount you can contribute must be reduced, figure your reduced contribution limit as follows.

  1. Start with your modified AGI.
  2. Subtract from the amount in (1):
    1. $198,000 if filing a joint return or qualifying widow(er),
    2. $-0- if married filing a separate return, and you lived with your spouse at any time during the year, or
    3. $125,000 for all other individuals.
  3. Divide the result in (2) by $15,000 ($10,000 if filing a joint return, qualifying widow(er), or married filing a separate return and you lived with your spouse at any time during the year).
  4. Multiply the maximum contribution limit (before reduction by this adjustment and before reduction for any contributions to traditional IRAs) by the result in (3).
  5. Subtract the result in (4) from the maximum contribution limit before this reduction. The result is your reduced contribution limit.

Backdoor Roth IRA to the Rescue

However, if you make more than the amounts in the table above, you don’t have to worry about any of this income limitation stuff if you know a neat little loophole.

You can make use of a “backdoor Roth IRA” to essentially bypass these income limits and get on track toward tax-free wealth building!

A backdoor Roth IRA is essentially a traditional IRA that is converted to a Roth IRA.

This works because traditional IRAs have no income limitations on who may contribute to them.

Setting up a backdoor Roth IRA is a 4-step:

  1. Set up a traditional IRA.
  2. Convert your traditional IRA to a Roth IRA.
  3. Pay tax on the conversion.
  4. Pay tax on gains in your traditional IRA.

Pretty much any reputable broker can do this for you.

How to Set Up a Backdoor Roth IRA at Vanguard

You can set one up at any brokerage.

The deadline to make a 2021 IRA contribution is April 15, 2022, so don’t delay!

Below is a video we made on how to set up a Backdoor Roth IRA at Vanguard!

Author:

Logan Allec, CPA

Logan is a practicing CPA, Certified Student Loan Professional, and founder of Money Done Right, which he launched in 2017. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.

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