Sunday Morning Quick Hits # 4: Don't Forget the Backdoor Roth IRA

The April 15, 2016 deadline to fund IRAs for 2015 is looming. If you think you are not eligible to fund a Roth IRA because you make too much money ... not so fast. Here's why.

It’s not a new retirement savings concept as it’s been available to high wage earners and their spouses since 2010. But it’s a great funding tool for Roth IRAs that’s very commonly overlooked for retirement.

Backdoor Roth IRAs are a planning technique that many financial advisors, banks and wealth managers don’t recommend for their clients unfortunately, either because they don’t understand it or worse, the financial professional may not even know about it.

Some investment firms also don’t want to increase their administrative workload by opening up a new, smaller account, that in the short run doesn’t pay them the fees they really like to earn. That’s shameful.

Here’s how it works to get money into a Roth IRA, when you may not be allowed to contribute to an IRA because your income (single or joint depending on filing status) exceeds IRS limits for direct contributions.

High wage earners who have modified adjusted gross incomes above $131,000 in 2015, or married couples with joint income exceeding $193,000, are not eligible to make a direct Roth IRA contribution. However, it’s perfectly permissible for those above the income limits to contribute to a nondeductible IRA (up to $5,500 if under age 50, and $6,500 if above age 50 in 2015), then convert that nondeductible IRA to a Roth IRA. That’s what tax advisors call the backdoor Roth IRA.

It’s not a smart retirement savings tool for everyone, however. If you have a traditional IRA, you may owe taxes on the conversion because the IRS looks to your taxable IRA balance first when calculating what you owe on converting. But if you have no traditional IRA, a backdoor Roth is probably intelligent to do. Or, if you have just a 401(k) account, it’s probably wise to do a backdoor Roth funding strategy. Spouses who don’t have a traditional IRA can also do a backdoor Roth IRA without incurring a taxable conversion.

Roth IRAs are the closest thing in retirement savings we have to a free lunch, offering lifetime tax-free money (subject to being 59.5 years of age and a five-year waiting period). Ask your CPA or financial advisor if you are eligible for a backdoor Roth IRA.