Stephen B. Jordan, EA: March 2020

Tuesday, March 10, 2020

A backdoor Roth IRA is not an official type of retirement account. Instead, it is an informal name for an, IRS-sanctioned method for high-income taxpayers to fund a Roth, even if their income is higher than the maximum the IRS allows for regular Roth contributions. The annual Roth IRA limit is $6,000 in both 2020 and 2019, up from $5,500 in 2018 (if you’re 50 or older, you can add $1,000 to those amounts).
TY2019 Traditional IRA phaseout (MAGI):

Backdoor Roth IRAs are not a special type of account; rather, they are usually traditional IRA accounts or 401-K's which have been converted to Roth IRAs. A backdoor Roth IRA is a legal way to get around the income limits that normally restrict high-earners from contributing to Roths. A backdoor Roth IRA is not a tax dodge—in fact, you might incur a small amount of tax when it's established—but it does provide investors with future tax savings.
Traditional IRAs don't have income limits. And since 2010, the IRS has not had income limits restricting who can convert a traditional IRA to Roth IRA. As a result, the backdoor Roth has become an option for higher-income taxpayers who ordinarily weren't able to contribute to a Roth.
The funds you put into the Roth are considered converted funds, not contributions. This means you have to wait five years to have penalty-free access to your funds if you’re under age 59½. In this sense, they differ from regular Roth IRA contributions, which you can withdraw at any time without tax or penalty.
You can do a backdoor Roth IRA in one of several ways:

The first method is to contribute money to an existing traditional IRA and then roll over the funds to a Roth IRA account. Or, you can roll over existing traditional IRA money into a Roth—as much as you want at one time, even if it's more than the annual contribution amount.
Second way is to convert your entire traditional IRA account to a Roth IRA account.
Third way to make a backdoor Roth contribution is by making an after-tax contribution to a 401-K plan and then roll it over into a Roth IRA.

Backdoor Roth is not a tax dodge. You still need to pay taxes on any money in your traditional IRA that hasn’t already been taxed.
10% Penalty and Roth IRA Conversions

While funds you convert to a Roth IRA are taxable no matter your age, the 10% penalty doesn't apply to conversions. Be careful here. Withholding funds to pay tax on the conversion results in a 10% penalty to the amount withheld. (Any amount not converted is a regular distribution).
For example, if you contribute $6,000 to a Traditional IRA and then convert that money to a Roth IRA, you’ll owe taxes on the $6,000, or whatever portion of your existing Traditional IRA basis ratio is to your rollover. IRS Form 8606 is used to help determine the taxable portion of a distribution or conversion and must be filed in the distribution year.) If you're non-deductible Traditional IRA contribution is immediately converted (rolled-over) into your Roth, (1099-R Box 7, Code "2" - Roth Exception),
You’ll owe taxes on whatever money it earns between the time you contributed to the Traditional IRA and when you converted it to a Roth IRA. (1099-R Codes for Box 7. ... Use Code 2 only if the participant has not reached age 59 1/2 and you know the distribution is: A Roth IRA conversion (an IRA converted to a Roth IRA) or a distribution made from a qualified retirement plan, or IRA, because of an IRS levy under §6331.

Stephen B. Jordan, EA