A backdoor IRA is not nearly as sketchy as it seems. It’s a totally legal way of getting all of the advantages of a Roth IRA even if you make more than the annual income limit for a regular Roth IRA.
It’s simple: you put funds into a traditional IRA, roll over those funds into a Roth IRA, and pay the taxes due.
Starting with a traditional IRA allows you to sidestep the Roth IRA income requirement. Furthermore, the maximum $6,000 annual contribution condition also doesn’t apply – you can roll over any amount of money from a traditional IRA in a given year, since it’s money you’ve already contributed from previous years.
Why Would You Go Through This Trouble to Open A Roth IRA?
A Roth IRA has a lot of potential benefits over a traditional IRA:
- You don’t have to wait until you’re 59 ½ to withdraw principal (money you put into the account, not your investment earnings). This is helpful for people who intend on retiring early.
- You are required to take minimum distributions from your traditional IRA starting at the age of 70 ½, which will spend down the money you can use to continue earning interest. This requirement does not apply to Roth IRAs.
- Your money in a Roth IRA grows tax-free, so any investment earnings that you make are tax-exempt.
So should everyone be running to, shall we say, get in the back door? Well…no. A backdoor Roth IRA is just a cool way of giving yourself an additional option for saving for retirement. Depending on your individual circumstances and the size of your existing traditional IRA, a backdoor Roth IRA could provide potential savings, or be a terrible idea due to all of the taxes you would have to pay upfront. Brokerages that provide traditional IRA and Roth IRAs such as Merrill Lynch, E-Trader, and TD Ameritrade, usually have professionals you can consult on whether backdoor Roth IRAs are right for you!