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March 2024 Financial Planning Newsletter -Back Door Roth IRA and roth 401k

Just like diversification within your investment portfolio, we normally recommend diversification of asset location, or the type of vehicle in which you are saving.  Having some savings in taxable accounts, some in traditional tax deferred accounts (401k or IRA), and some in Roth retirement accounts gives investors more control over spending and tax impact in the future.   

However, many investors can’t contribute directly to a Roth individual retirement account (IRA) due to income limitations. For 2024, the income limits are $161,000 for single, and $228,000 for joint filers, and this number is based on modified adjusted gross income (MAGI). When your income exceeds this, it requires planning to determine “how” and “if” you can utilize a back door Roth IRA to better prepare for retirement.

So, what are your options?

The most prominent strategy for those above these limits is to do what has been termed the “back door Roth IRA.” In this strategy, you contribute to a traditional IRA, but take no deduction for it, (also known as a “non-deductible IRA”) and then immediately convert this money to a Roth IRA. Because you never took a deduction for the contribution, the conversion is typically tax-free (Please consult your tax professional for your specific situation). The immediate part is important, as any growth in the traditional IRA would be subject to taxes during the conversion process.

The other popular strategy is to contribute to a Roth 401k through your employer. This has become much more popular in recent years with a wider range of investment and account type options hitting the market. This option has no income limits like highlighted above which means anyone can use this option if it is offered. There are a couple benefits to this method over the back door Roth. This is much simpler as it doesn’t require any conversion. You just need to change your “deferrals” (Also known as contributions) to Roth from Traditional in your human resources portal or on your 401k holder’s website. The other benefit is the amount you can contribute. The IRA contribution maximum is $7,000 (If you are under 50) but is $23,000 for your 401k.

It is important to note this is a high-level overview, and other rules may impact your eligibility or suitability for this. If you are curious about these strategies and how they may impact your retirement planning, this is a great time to reach out and start the conversation.