Backdoor Roth IRA Conversions Alive and Well

hi I'm Christine Benz for morningstar.com eight years after their arrival backdoor Roth IRAs are alive and well joining me to discuss the maneuver is IRA expert Eadie slot he's author of the newly revised retirement decisions guide and thank you so much for being here great to be back here in Chicago we're thrilled to have you in the studio one topic that comes up a lot with our readers and viewers on morningstar.com is this idea of the back door Roth IRA let's talk about who should consider using the backdoor IRA backdoor Roth IRA maneuver and really who doesn't have to consider it it's exactly as you say it's a maneuver it's a made-up term backdoor Roth IRA but here's the situation it's a way to get money into a Roth IRA when you otherwise wouldn't qualify now just to be clear there's two ways to get money into a Roth IRA the big money is in the conversions you can convert a billion dollars I mean if you had the money right and there's no income limits on that but if you want to put fifty five hundred in a Roth IRA as a contribution then we're gonna lower the book then we want limits this is out of control nobody knows why why do they have limits on such smaller amounts compared to the larger conversions but that's where we are so we're not talking about conversions which are unlimited anybody can do those we're talking about the $5,500 a year Roth IRA contributions or 6,500 if you're 50 or over they do have income limits okay nobody knows the reason but they have limits so it's not available to higher income taxpayers the limits are relatively high for most people but there's a lot of people watching now that are over those limits that would like to make a Roth contribution so what developed over time has become known as a backdoor Roth or a workaround and nobody liked that term especially we're just finding out now people at IRS never liked those terms there was a spokesperson that just came out recently and said that was the only problem we had we just didn't like the name found it illicit or something like that so here's how it works you start with a tradition IRA why because unlike a Roth IRA contribution that has income limits right there are no income limits for who can contribute to a traditional IRA now I'll just stop there because some people will say no no there are income lutely right that's only for deductibility if you have if you're active in a company plan but there are no income limits for who can contribute you just may end up with a non-deductible IRA that's all so we're so the process starts with a contribution to a non-deductible IRA for which there are no limits you could make a million dollars a year and you can contribute the fifty five hundred and then you convert it to a Roth now you're right back where you want it to be you have the same fifty five hundred or sixty five hundred in a Roth IRA even though you were over the limits now there was a lot of chatter about this over the years oh well that's illegal you know you're getting to a place where the law says you're not allowed to be people called it a step transaction and other legal things you have to worry about any of that anymore I'm not even gonna get into that I was never in that camp by the way I always thought it was fine but now under the new tax law which this is not in the new tax law but in the Congressional conference report this this backdoor Roth not mentioned by name but the actual procedure or the mechanism is mentioned four times four times they they state explicitly that this is allowable they say you can make a contribution to a traditional non deductible IRA and converted to a Roth so IRS came out recently and said well if Congress says it's okay we're good with it we won't challenge it and that's where the spokesperson who said that said we really just were uncomfortable we just didn't like the name interesting so there had been some advice out there in the past that you referenced it people had a sense well if I do this I should wait between these two transactions so fund my traditional IRA and then perhaps wait a year even until I do this conversion is there reason to wait around between these two transactions and your view not anymore but I was one of those people I think right on this program maybe a few years back I said I never said wait a year I always said have it show up even today I might do that just for the tracing rules to see where it went have it show up make your contribution to a traditional IRA so wait till one statement say a month so you can see it in the traditional IRA and then convert to a Roth you don't have to but if you want to see where it came in you see it in one account and then another is a clear path but it's absolutely legal IRS won't challenge it but there are cautions to it not everybody qualifies and remember this whole process starts with a contribution to a non-deductible traditional IRA now to make a contribution to a traditional IRA you have to be eligible you can't just put money in just because IRS says the backdoor Roth is okay you still have to qualify which means you have to have earnings w2 income self-employment income like it would make any eye are a contribution also you can't be over 70 and a half because currently IRA or the tax rules say after 70 and a half you can no longer make traditional IRA contributions it's odd because with the Roth it's opposite there is no age right right but there's a proposal now floating around Congress saying to eliminate that 70 and a half rule so we'll see if that happens but for right now once you're over 70 and a half this won't work for you because remember the process starts with a contribution to a traditional IRA and if you're not eligible you can't start the process also you have to be aware because some people I've seen even financial advisers say yeah this is a great thing take your fifty five hundred put in a non-deductible traditional IRA convert it to a Roth no tax that's not always the case it's in fact it's not the case for most people because most people have other IRA balances including SEP and simple IRAs so traditional IRA balances right right so for example let's say you want to do this with five thousand you do a contribution to a non-deductible traditional IRA for five thousand and you convert it to a Roth but if your total IRA balance of including all your other traditional IRAs is a hundred thousand then 95% of that conversion will be taxable it's called a pro rata rule you have to take the other funds into account now it's not the end of the world because we're only talking about the tax on a 5500 dollar contribution or $6,500 contribution and the other thing is this money goes in as a Roth conversion not a contribution there's a big difference here but it's only a difference if you're under fifty nine and a half with a Roth contribution when you put that contribution money in you can withdraw at any time for any reason tax and penalty free the contribution is right but not the conversion the converted funds have to be held five years so if you're on and that's only if you're under fifty nine and a half for the ten percent penalty if you're not if you're over fifty nine and a half this makes no difference for you so it's just to keep in mind that and if you're going through the effort of doing this you're probably going to keep it for the five years anyway why would you go through all this if you needed the money but you never know right so you reference that Congress has looked at kind of harmonizing the rules about Roth and traditional IRAs question is if this loophole is here and seemingly on the up-and-up why doesn't Congress just officially bless it by lifting the age limits on Roth IRA or lifting the income limits on Roth IRA country they should do it are you listening do they watch Morningstar I mean it seems like a no-brainer especially when conversion money where all the big money is there's no income limits so why are there income limits just one of those things that got in the tax code and just never got out you're absolutely right why don't they just get rid of all this and say no more income limits for making Roth IRA contributions now some people say oh that's another big break for the wealthy but you're only talking about a $5,500 contribution or a $6,500 contribution each year Why should there be income limits okay and important topic I know a lot of our viewers have been really interested in this back door raw thing things so thank you much for being here thanks great to be here thank you thanks for watching I'm Christine Benz for morningstar.com [Music]

Channel: Morningstar, Inc.

Views: 43,226

Keywords: morningstar, investing, stocks, funds, etfs, mutual, market

Id: E43iCJ2Ut58

Length: 9min 2sec (542 seconds)

Published: Fri Aug 17 2018