What Is A Backdoor Roth IRA? The Buzz Surrounding Biden’s Changes

According to research from the Investment Company Institute, 43.9 million US households own at least one type of IRA. Clearly, tons of people understand just how lucrative investing in this type of retirement account can be. Investing in a Roth IRA is one of the best ways to save for retirement today. However, if your income is too high, you may be prohibited from contributing to a Roth IRA. 

At least, that’s the idea with Biden’s new proposed social legislation as part of the Build Back Better bill. What’s the idea there? The goal is to limit tax-avoidance strategies favored by the ultra rich, which all in all serves to level the playing field for everybody else. What if you still want to avoid the rules, too?

Luckily, there is a completely legal way to get around these restrictions by utilizing the “Backdoor Roth” strategy. Read on to find out how you can use this method to reap the benefits of Roth IRAs.

What Is a Backdoor Roth IRA?

You’ve probably heard of Roth IRAs, as they are an increasingly popular way to save for retirement, mainly due to their simplicity and tax advantages. If you haven’t, then start by reading through our helpful guide on How Retirement Accounts Help Build Wealth.

Ultimately, what you want to know about Roth IRAs and retirement accounts in general is that they can help you grow your money in a way that’s tax-advantaged. Roth accounts aren’t the same as traditional ones, though, and when you invest in a Roth IRA you’re investing post-tax dollars. This means that they’re ideal for those currently in a low-income tax bracket and aspire to be in a higher income tax bracket later.

Not convinced just how much they can help you grow your wealth? Roth IRAs are so beneficial that the IRS limits eligibility to participate in the plans based on income levels. 

Many high-income earners want the opportunity to contribute to Roth IRAs, but their income prohibits them from doing so. Here are the Roth IRA income limits for 2021:

  • Income must not exceed $140k if you file your taxes as a single person
  • Joint income must be under $208k if you file taxes as “married filing jointly.”

Roth IRAs are particularly attractive to high-income investors due to the tax benefits. For example, Roth investors don’t pay taxes on investment growth or withdrawals after age 59 ½.

If you don’t fall within the income thresholds, you can still contribute to a Roth IRA by using the backdoor Roth strategy. Let’s find out how. 

How Does a Backdoor Roth IRA Work?

The process of investing in a Backdoor Roth is simpler than it sounds. To invest in a Roth IRA using the backdoor method, here are the steps you need to take:

Contribute to a Traditional IRA → Transfer the money into a Roth IRA = Backdoor Roth

To complete this process, the first step is to open a Traditional IRA and a Roth IRA if you don’t have them already. Some common brokerage firms people use to open IRA accounts are Fidelity, Vanguard, and Schwab. 

After you open your accounts and complete the backdoor Roth process, it’s time to invest your money. If you forget this step, your efforts will be for nothing– since the funds you contributed will sit in a money market account, earning you less than .1% in interest

How Much Can You Put In a Backdoor Roth?

A key advantage of the Backdoor Roth strategy is that you get around the income restrictions and avoid the annual contribution limits. For example, the maximum allowable contribution to a Roth IRA in 2021 is $6,000 ($7,000 if you’re over age 50). However, funding a Roth IRA using the Backdoor Roth strategy is considered a conversion instead of a contribution. Therefore, the standard rules don’t apply. 

How Does Biden’s Policy Changes Impact Backdoor Roths?

You may have heard about Backdoor Roths in the news recently. That’s because House Democrats proposed several changes to the tax code in the Build Back Better plan. The impacts on Roth IRA investors likely won’t be felt for years, with the new provisions set to go into effect between 2028 and 2032. 

Here’s what could change for Backdoor Roth investing in the years to come:

  • Backdoor Roths would be prohibited for singles earning more than $400k per year and couples making above $450k.
  • Backdoor Roths wouldn’t be allowed for those with total retirement account values that exceed $10 million.

The Build Back Better plan hasn’t been finalized and still needs to be passed by Congress. Therefore, it’s possible these changes won’t even make it into the final version of the legislation. And, unless you’re earning millions of dollars a year (which, you could be when you start using Wealth Stack to optimize your wealth), it likely won’t make too much of a difference in your overall retirement investment strategy and returns.

Next Steps: Start Building Wealth with Wealth Stack

Saving for retirement can be confusing, and we definitely understand that. It’s why we’ve created easy to implement solutions that will help you invest wisely. 

Not only are we now offering IRA Stack, a customized solution for small business owners looking to offer retirement options to their employees, but we’ve also got hundreds of free videos and guides that you can use to help you learn how to start investing in your future.

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