What is a “Backdoor Roth”?
Backdoor roth is when one contributes to a non-deductible (after-tax) Traditional IRA and then converts the contribution into a Roth IRA. Backdoor roth is a great alternative for high income earners who do not qualify contribute directly into a Roth. The individual may contribute to the Traditional IRA the maximum amount allowed $6,000 ($7,000 if the individual is 50 years or older) for 2020. Then convert this amount immediately. Generally, the individual does not pay taxes on this conversion since the contribution to the Traditional IRA was after-tax (please read the pro-rata rule for how much of the conversion is taxed).
This rule applies when an individual owns other pre-tax retirement accounts, such as Rollover IRAs, Traditional IRAs, SEP IRAs, and SIMPLE IRAs. The values of these accounts may determine how much of your backdoor roth conversion will be taxed.
For example, if your other retirement accounts’ total value is $100,000, from that total, $90,000 is pre-tax and $10,000 after-tax. Then when you convert $10,000 into your Roth, 90% of the conversion will be taxable. The $9,000 will be taxed at your ordinary income rate.
There is a way to reduce your pre-tax retirement account value. You can roll the existing pre-tax retirement accounts into an existing 401k account (if permitted by the employer). If you are self-employed, you may roll into an Individual or Solo 401k account.
Please consult with your tax advisor before making any conversions to ensure that you can benefit from the conversion.