1. Home
  2. Knowledge Base
  3. Backdoor Roth IRA – Definition

Backdoor Roth IRA – Definition

Backdoor Roth IRA Definition

A Backdoor Roth IRA is an approach used by high-income individuals or taxpayers to contribute money or make savings into a Roth IRA. Usually, the Internal Revenue Service (IRS) disallow high-income individuals from saving in a Roth IRA but taxpayers that the backdoor, using tax loopholes to contribute indirectly into a Roth IRA.

Any individual with an income higher than the maximum income that IRS allows for Roth IRA can use the backdoor to contribute indirectly into Roth IRA. A Backdoor Roth IRA is an informal name for a retirement account, methods that taxpayers can use to contribute indirectly into a Roth IRA are developed by professional brokers.

Takeaways

  • Backdoor Roth IRAs is a conversion method that taxpayers use in converting traditional IRA accounts to Roth IRA.
  • Individuals with incomes that exceed the maximum amount that IRS allowed in a Roth IRA use the backdoor approach.
  • Methods used for contribution into a Roth IRA account are developed by IRAs brokers, they also assist taxpayers.

A Little More on What is a Backdoor IRA

In a typical Roth IRA, taxpayers are allowed to set apart a percentage of their after-tax income for the purpose of retirement. Money saved up in Roth IRA accounts increase over time and the fund is tax-exempt. Individuals who earn more than the threshold are disallowed to use a Roth IRA.

In the case of a backdoor Roth IRA, individuals that earn above the threshold are allowed to participate in Roth IRA using the backdoor and other strategies. Taxpayers can also make a contribution into a 401 (k) plan and roll the contribution over to a Roth IRA, this is a form of Backdoor Roth IRA. This backdoor approach allow the conversion of a traditional IRA to Roth IRA.

Taxpayers do not struggle to participate in Roth IRA using a backdoor Roth contributions without any reason. They do this because of the benefits attributed to Roth IRA. Taxpayers use Backdoor Roth IRA for the following reasons;

  • Roth IRA minimizes taxes, the account is tax-exempt in so far its holder is still alive.
  • Taxpayers make significant savings through Roth IRA because the accounts are not taxable.
  • It offers growth of income to taxpayers. For instance, a taxpayer who begins a backdoor contribution at the age of 30 will have an estimated amount of a quarter of a million dollars at age 90.
  • Roth conversion attract a tax bill but a backdoor Roth prevents or minimizes the tax hit.

Reference for “Backdoor Roth IRA”

Making a” Backdoor” Roth IRA Contribution, Mollberg, K. T. (2013). Making a” Backdoor” Roth IRA Contribution. Journal of Accountancy215(4), 72.

The Front Door Opens Wide for the Backdoor Roth IRA, Manns, F. P., & Todd, T. M. (2017). The Front Door Opens Wide for the Backdoor Roth IRA. Invoking allusions to Caligula and Roman tax law, the Sixth Circuit, in Summa Holdings, reversed the Tax Court and held that the Commissioner could not use the substance-over-form doctrine to prevent taxpayers from combining the tax savings effects of a domestic international sales corporation with a Roth IRA. In this article, we argue that the Summa Holdings rationale supports and allows the backdoor Roth IRA — that is, making a nondeductible, traditional IRA contribution and then converting it into a Roth IRA (ostensibly to avoid the income limits on direct contributions to Roth IRAs).

Self-Directed IRAs: A Tax Compliance Black Hole: Nontraditional Investments Favored by Many Self-Directed IRAs Can Lead to Unexpected Taxation of Unaware IRA …, Baker, W. L. (2013). Self-Directed IRAs: A Tax Compliance Black Hole: Nontraditional Investments Favored by Many Self-Directed IRAs Can Lead to Unexpected Taxation of Unaware IRA Account Holders. Journal of Accountancy216(4), 44.

Was this article helpful?