In this video and article I explain how I personally use a backdoor Roth option to save significant money each and every year.
The quick nuts and bolts
Let's get to the point and I'll explain what I do each year:
- My wife and I each have both a traditional IRA and a Roth IRA at our brokerage.
- Each year we each contribute the maximum amount to our traditional IRA accounts (currently $6,000)
- We cannot deduct this contribution on next year tax returns. It's after-tax money.
- A few days later once the transfer is complete, I transfer 100% of the money from our traditional IRA to our Roth IRA.
- I then invest that money per our investment policy (into stocks, bonds, etc)
That's it. It now grows tax free over the coming years (hopefully!) and it's 100% all our money (no taxes owed).
It can't be that easy?
It's true, I've skipped a lot of details in the setup of the above. However, yes it's that easy each year now. The big caveat and what you'll find with some online research, is that doing a backdoor Roth requires to take into account all your existing traditional IRA, SEP IRA and Simple IRA accounts. Any money that is in those accounts tax-deferred (you took a tax deduction or it's had growth) is taken into account during the backdoor conversion to see if you owe current taxes. So, you have to do a big conversion first, partial conversions or some other transfer - and that's definitely got a lot more tax implications.
If you have no money in a traditional IRA, SEP IRA or Simple IRA - then it's super easy: you can perform the steps I mention at the outset.
How much is it worth?
Here's the fun part: you can save a lot of money over the years because a Roth account is 100% your money, you don't owe any taxes. Let's make some basic assumptions: 7% growth rate and 24% tax bracket in retirement. By the end of 20 years that $6k has grown to just over $23k. In a traditional IRA, you owe taxes of over $4k, but owe none if that's in a Roth IRA. That's the power of doing the backdoor conversion and getting that investment into a Roth IRA. And, if you and your spouse both contribute, that's double savings!