Tags: Bankrate | backdoor | Roth | IRA

Bankrate: 'Backdoor' Strategy Can Get High-Income Earners Into Roth IRAs

Tuesday, 19 Aug 2014 11:55 AM

By Michelle Smith

Due to income restrictions Roth IRAs are generally off limits to high-income earners, unless they use the 'backdoor' strategy, Bankrate explains.

In 2014, individuals younger than 50 can put $5,500 of their taxed earnings in a Roth IRA, and people 50 or older can contribute $6,500.

Roth IRAs have a number of attractive benefits, including contributions are already taxed so the money grows and can be withdrawn tax-free, the money only has to remain in the account for five years and then can be withdrawn regardless of age and the funds can be left in the account forever, Bankrate notes.

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But if you're single and your modified adjusted gross income (AGI) is $129,000 or more or you're married filing jointly and your modified AGI is $191,000 or more, IRS rules prohibit you from contributing to a Roth IRA.

The backdoor strategy provides a workaround.

Anyone can contribute to a nondeductible IRA, in which only the earnings are taxed when withdrawals are made, according to Bankrate. And since 2010, anyone, regardless of income, can convert those nondeductible IRAs into Roth IRAs, hence the term backdoor.

Going through the back door is one of the only ways that high earners can get money into a Roth IRA, Lynn Mayabb, managing director at BKD Wealth Advisors, tells Bankrate.

"If you're saving anyway, why not allow your money to grow tax-free and be tax-free in the future?" she questions.

However, financial experts warn that individuals must exercise caution if they plan to use the backdoor Roth IRA strategy because it might not be a good idea for everyone.

"You have to consider all your IRAs and where those dollars came from," Mayabb notes. "If you have another IRA out there and if you originally took a tax deduction on those dollars, that will affect your tax liability on the Roth IRA."

"If you screw up the calculations or if the custodian does, there could be a problem with the IRS," warns Jean Dorrell, a certified estate planner and founder of Senior Financial Security in The Villages, Fla.

Moreover, since the backdoor Roth IRA strategy is fairly new and no one has reached eligibility for the five-year withdrawal, no one knows how severely those IRS actions will be, Dorrell tells Bankrate.

Therefore, the backdoor IRA strategy is best for high-income earners "who don't have other IRAs or who have rolled deductible IRAs into a 401(k) plan, eliminating it from being considered," Mayabb adds.

It's never been more important to shield as much income from taxes as possible, writes Forbes contributor Ron Berger.

The highest individual federal income tax rate is 39.6 percent. Add payroll taxes, state and local income taxes, alternative minimum tax and loss of the value of deductions and exemptions, and many people keep less than they pay in taxes above certain income levels, Berger argues.

Editor’s Note: Dow Predicted Will Hit 60,000 — Buy These 4 Stocks Now

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