Retirement planning is a critical component of financial security, and one of the most popular tools for long-term savings is the Individual Retirement Account (IRA). Among the various types of IRAs, the Roth IRA stands out for its tax-free growth and withdrawals, making it a highly attractive option for those planning for their retirement. However, Roth IRAs come with income limits that can restrict high earners from contributing directly. This is where the Backdoor Roth IRA strategy comes into play, offering a valuable workaround for those whose Modified Adjusted Gross Income (MAGI) exceeds the Roth IRA contribution limits.
Understanding the Backdoor Roth IRA Strategy
A Backdoor Roth IRA is not a special type of account but a strategy allowing high-income earners to bypass the income restrictions associated with Roth IRAs. The strategy involves contributing to a traditional IRA, which has no income limits, and then converting those funds to a Roth IRA. This conversion may allow individuals to take advantage of the Roth IRA’s tax-free growth and withdrawals, even if their income exceeds the Roth IRA contribution limits.
Why Consider a Backdoor Roth IRA?
In 2024, the income limits for contributing to a Roth IRA are $146,000 to $161,000 for single filers and $230,000 to $240,000 for married couples filing jointly. If your MAGI exceeds these limits, you cannot contribute directly to a Roth IRA. However, you can still benefit from a Roth IRA by using the Backdoor Roth IRA strategy, which involves converting a traditional IRA into a Roth IRA.
This strategy is particularly beneficial for those who expect to be in a higher tax bracket during retirement. By locking in tax-free growth now, you can potentially save a significant amount in taxes later. Additionally, Roth IRAs do not require minimum distributions (RMDs) during the account holder’s lifetime, providing more flexibility in managing your retirement income.
Steps to Set Up a Backdoor Roth IRA
Implementing a Backdoor Roth IRA involves a few straightforward steps. Here is how we can work together to set you up for success:
- Open a Traditional IRA: We’ll start by opening a traditional IRA if you don’t already have one. You’ll fund it with after-tax contributions. If you already have a traditional IRA, we’ll keep the IRA aggregation rule in mind (this may trigger unexpected taxation), as it could impact the tax implications when we convert to a Roth IRA.
- Convert to a Roth IRA: Once your traditional IRA is funded, we’ll move forward with the conversion to a Roth IRA. We will work with our custodian to guide you through the process and ensure the conversion is completed by December 31 to include it in this year’s taxable income.
- File IRS Form 8606: This form is essential for reporting the nondeductible contributions to your traditional IRA and tracking your basis in the account. Filing this form correctly ensures that you do not pay taxes on the nondeductible portion of your conversion.
- Plan for Taxes: Be prepared to pay taxes on any converted earnings or deductible contributions. To maximize your Roth IRA’s benefits, we will make sure you have cash on hand to cover the tax bill, rather than using the converted funds.
By working together through these steps, we will ensure a smooth and tax-efficient process, allowing you to make the most of your retirement strategy.
Key Considerations and Potential Pitfalls
While the Backdoor Roth IRA offers significant advantages, it’s important to approach this strategy with a full understanding of the potential tax implications and complexities involved. Here is how we can work together to determine if a Backdoor Roth IRA is the right strategy for you:
- Tax Implications: When we convert your traditional IRA to a Roth IRA, you’ll owe taxes on any deductible contributions and earnings. If your IRA includes both deductible and nondeductible contributions, the IRS’s pro-rata rule will apply. This rule calculates taxes based on the ratio of these contributions across all your IRAs, which could result in a higher tax bill (this may trigger unexpected taxation).
- Pro-Rata Rule: The IRS treats all your traditional IRAs as one entity when calculating the taxable portion of a conversion. For example, if 90% of your IRA funds are deductible, 90% of the converted amount will be taxable, complicating the conversion process if you have multiple IRAs with mixed contributions.
- 5-Year Aging Rule: Any funds converted to a Roth IRA must stay in the account for 5 years before you can withdraw them tax-free. If you withdraw early, you could face a 10% penalty, separate from the rules for direct Roth IRA contributions.
- Impact on Tax Brackets: The conversion could potentially push you into a higher tax bracket, increasing your overall tax liability. We’ll work together to plan the timing of your conversion carefully to manage this impact. Consulting with a tax professional can also provide additional guidance to optimize your tax strategy.
Is a Backdoor Roth IRA Right for You?
A Backdoor Roth IRA can be a powerful tool for high-income earners seeking to benefit from Roth accounts’ tax benefits. However, the strategy is not suitable for everyone. If you have significant deductible contributions in your traditional IRAs, the tax implications of a conversion could outweigh the benefits. Additionally, if you anticipate needing to access the converted funds within five years, the 5-year aging rule may reduce the strategy’s effectiveness.
Before proceeding with a Backdoor Roth IRA, it’s crucial that we consult together and with a tax professional. Our goal is to help you navigate this strategy’s complexities, ensure compliance with IRS rules, and optimize your retirement savings plan. We will be with you every step of the way to make sure this strategy aligns with your financial goals.
Enhancing Your Savings
The Backdoor Roth IRA is a powerful tool for high-income earners, allowing us to bypass the income limits on Roth IRA contributions. This strategy lets you take advantage of the benefits of tax-free growth and tax-free withdrawals in retirement.
By working together to understand how this strategy works and carefully planning for the associated tax implications, we can enhance your retirement savings and provide you with more financial flexibility. Our goal is to ensure you maximize the benefits while minimizing any potential pitfalls.
As with any retirement strategy, staying informed and seeking our advice is crucial. We will be here every step of the way to guide you through the process and make sure you’re getting the most out of your retirement savings.
If you have any questions or want to learn more about how a backdoor Roth IRA conversion affects your financial plan or taxes, feel free to give us a call. For strategies and information on minimizing your tax burden, you can also check out Chapter 6 of ‘Wealth on Purpose’ by Bryan Ballentine.
Sources: Located at the bottom of the article
Golf Tip of the Week
Jordan Spieth admits to making big mistake during recent buddies golf trip to Ireland
It wasn’t quite the glory days #SB2K17, but most of that crew—Jordan Spieth, Justin Thomas, and Smylie Kaufman—were recently together on a buddies golf trip to Ireland. Not surprisingly, it looked like the boys had a great time. But surprisingly, Spieth made a big mistake in an area he usually specializes in.
We’ve heard JT praise Jordan for his ability to keep a clean scorecard in the past. And no, we’re not talking about his actual round, but how he keeps track of everyone’s score.
“There may be nobody on planet Earth that is better at keeping a scorecard and keeping track of bets than he is,” Thomas said of his longtime pal on the Smylie Show last year.
That’s high praise. And Spieth is always entrusted to keep the group’s scorecard. But apparently, the three-time major champ was way, way off his scorecard game in Ireland. Leading to a lot of confusion on the course—and this funny discussion between all three this week:
The gist of the story is that Spieth messed up the scorecard so badly that he had to take a break while he tried to figure out why $140 in bets were missing.
“I just didn’t even play a hole because I’m trying to figure out these numbers,” Spieth said on this week’s The Smylie Show. “We never got there.”
Tough scene. Well, at least those guys were there in Ireland. Poor Rickie Fowler must have been on dad duty.
Hey, it happens. Heck, keeping track of Spieth’s wild scorecards is tough by itself. Then you factor in some beers, and, well, things can get sloppy. We’ve got faith in Jordan bouncing back from this. And these guys will all survive no matter how that missing $140 gets resolved.
Tip adapted from golfdigest.comi
Recipe of the Week
Grilled Watermelon Salad with Sweet and Spicy Vinaigrette
Ingredients
Vinaigrette:
1/2 cup plus 2 tablespoons olive oil
1/4 cup honey
1/4 cup freshly squeezed lime juice (from 2 to 3 limes) plus zest of 1 lime
1/4 cup minced shallots (from 1 large)
3 tablespoons hot sauce, preferably Texas Pete
2 large garlic cloves, minced
Kosher salt and freshly ground black pepper
Salad:
2 tablespoons salted butter
1 cup pecan halves
2 tablespoons brown sugar
1 small seedless watermelon
One 5- to 6-ounce box baby arugula
1 cup sliced strawberries
1/2 cup blueberries
4 ounces premium-quality blue cheese
1/4 cup chopped fresh parsley
1/4 cup sliced scallions
Directions:
- For the vinaigrette: Combine the oil, honey, lime juice, zest, shallots, hot sauce, garlic and salt and pepper in a bowl to make a sweet and spicy vinaigrette. Set aside.
- For the salad: Line a baking sheet with wax paper and set aside. Melt the butter in a large skillet over medium heat. Toss in the pecans and brown sugar, stirring to coat. Cook over medium heat until the sugar begins to caramelize, about 3 minutes. Spread out pecans on prepared baking sheet to cool.
- Heat an outdoor gas grill to high or prepare a charcoal grill for high, direct-heat grilling. Trim the ends off the watermelon. Stand the watermelon on one cut end and cut in half, then cut each half in half again. Cut the quarters into 1/2-inch-thick slices. Brush the vinaigrette on both sides of the watermelon slices. Add the watermelon slices to the grill in a single layer and cook until warmed through and grill marks appear, 2 to 3 minutes per side. Cool the watermelon, then cut into cubes. (You won’t use all the watermelon for the salad. Use as much as you like.)
- Layer the arugula leaves, grilled watermelon, strawberries, blueberries, blue cheese, pecans, parsley and scallions in a salad bowl. Add vinaigrette and toss just before serving.
Recipe adapted from foodnetwork.comii
Travel Tip of the Week
This Packing Spreadsheet Is Going Viral — and You Can Get It for Free
There are endless tips out there to help you pack for an epic trip — from the type of luggage to use to maximize space to whether or not to bring packing cubes, right down to creating a personal lookbook. But there’s one packing hack going viral on TikTok that you need to see — and all it takes is an Excel spreadsheet.
The tip is from TikTok user Luke Scarpino, whose video showing how he uses a spreadsheet so he doesn’t forget anything has amassed more than 8.8 million views, 1.2 million likes, and more than 29,000 comments, including from some big-name travel brands. The remarkable response led Scarpino to create a free template travelers everywhere can download and copy.
In the video, Scarpino details how he lists every item he wants to pack and the associated bag it goes with. He then has a checkmark for every item to click once he packs it to see what’s missing and what’s not before his trip. Scarpino can even filter his list and only look at one bag at a time.
“Everyone makes fun of me for how I pack, but I think I’m just organized,” he says to the camera, adding, “Am I weird for this?”
The internet responded with a resounding “no,” with hundreds begging for a template they could use themselves. Even Google (or at least the social media manager behind Google’s TikTok account) wanted in on the action, calling the hack “so beautiful” in the comments. Tripadvisor also responded, saying, “Is it normal? No. Is it the most beautiful thing we’ve ever seen? Yes.” Utz Snacks wanted to know if there was a specific row in his spreadsheet for snacks, and Booking.com said it “has no choice but to stan.”
Another user pointed out that the list is a built-in inventory in case an airline loses your bag. Scarpino also noted, “The fun thing is if you use this same list when it is time to return home, you will never forget something at a hotel again.”
Tip adapted from travelandleisure.com iii
Copyright © 2021. Ballentine Capital Advisors. All rights reserved.
Our mailing address is:
Ballentine Capital Advisors
15 Halton Green Way
Greenville, SC 29607
Sources:
How Does a Backdoor Roth IRA Work?
Backdoor Roth IRA: What it is and how to set it up
Backdoor Roth IRA: Is it right for you?
Disclosure:
Ballentine Capital Advisors is a registered investment adviser. The advisory services of Ballentine Capital Advisors are not made available in any jurisdiction in which Ballentine Capital Advisors is not registered or is otherwise exempt from registration.
Please review Ballentine Capital Advisors Disclosure Brochure for a complete explanation of fees. Investing involves risks. Investments are not guaranteed and may lose value.
This material is prepared by Ballentine Capital Advisors for informational purposes only. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation or any particular security, strategy, or investment product.
No representation is being made that any account will or is likely to achieve future profits or losses similar to those shown. You should not assume that investment decisions we make in the future will be profitable or equal the investment performance of the past. Past performance does not indicate future results.
Advisory services through Ballentine Capital Advisors, Inc.
