Backdoor Roth process:
1. Make a non deductible contribution to a traditional IRA
2. Convert the contribution to Roth
Just that simple. You can do this for both you and a spouse.
Some gotchas:
1. If you have any money anywhere in a traditional IRA, you will be subject to the pro rata rule and that can create some serious reporting and tax headaches. So, if you already have money in tIRAs, then get really smart or find a CPA that is really smart (most are clueless when it comes to backdoor Roths). If you do have tIRAs and a 401k, you could see if you can roll the tIRAs into your 401k if your 401k allows it and your 401k has good funds. 401k balances are not subject to the pro rata rule.
2. If you have ANY earnings on the tIRA contributions when you do the conversion, you can leave them in the tIRA and pay no taxes. But that will create headaches if you want to do another backdoor Roth next year. What I do is just convert the earnings to Roth and pay the taxes at the time. Since I only wait a week between contributing to the tIRA and converting to Roth, I usually have no earnings. Makes life easier.
3. Filling out the 8606 tax form is a must and can be baffling. I keep very careful track of all of my Roth conversions as well as filing the 8606.
Withdrawing from a Roth is fairly complex if you have contributions, conversions and/or earnings. If you are over 59 1/2, withdraw away. No taxes, no penalties. If you are under 59 1/2, you can always withdraw contributions tax and penalty free. But a backdoor Roth is NOT a contribution, it is a conversion and that has special rules for withdrawals. Here are the Roth withdrawal rules:
ORDER OF DISTRIBUTIONS
Regular contributions
Taxable portion of first conversion
Nontaxable portion of first conversion
Each subsequent conversion, in order, with the taxable portion coming out first for each conversion
Earnings (any increase in value occurring inside the Roth IRA)
TAXES AND PENALTIES
UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET
Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-Yes (Taxable Portion)
Conversions: Tax-No ;Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes
UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET
Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes
OVER AGE 59.5
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA
Contributions: Tax-No ;Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-No
OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA
All Distributions Are Qualified
No Taxes
No Penalties
Another very cool option is the mega backdoor Roth. This is where you make after tax contributions to your 401k (not Roth 401k) and then do an in-service rollover of that money into an external Roth. Your plan needs to allow this. Mine does and I have been cramming $19,500 a year into my Roth. Add that to the $14k between my wife and I backdoor Roths, and we are putting a lot of money each year into our Roths. By the time I retire, there will be a significant balance in all of our Roths. And it has a lot of earnings that will come out tax free.
Are you cornfused now? I'm still not sure I get all the little details, but I am comfortable putting the money in.
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