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“Back Door” Roth

Posted by McDonald & Osborne Posted on Oct 14 2015

While thinking ahead to retirement, millions of Americans sit down with their spouses, children and/or financial advisors to project how much they need to save to cover their expenses for the rest of their lives. First they look at health care costs (and rightfully so). Then they ask questions such as whether or not they will still be paying on their mortgages in retirement – or will they sell the place and downsize? They make plans for travel, entertainment… all the fun stuff. Ok, got it covered right? Well, a recent Lincoln Financial survey suggests that “retirees significantly underestimated the impact taxes would have on them in retirement”.

One way to lower, or at least hedge your tax costs in retirement is to contribute to a Roth instead of a Traditional IRA, especially if you are young and/or in a fairly low tax bracket. While a Roth offers no upfront tax deduction for contributions made during the year, the earnings can grow tax-free over time and you will pay no income tax in retirement when you distribute the funds. Sounds like a clever way to stash away some cash for the future right? Well it is. However one problem that many of our clients have (and a good one to have I might add) is that once a married couples’ income reaches $191,000 (or $129,000 for singles) they are no longer eligible to contribute to a Roth. Bummer.

Solution: You can make a contribution to a non-deductible IRA, and immediately instruct your financial adviser or financial institution to convert the IRA to a Roth. Yes, this is a legit strategy. Normal IRA contribution limits apply – $5,500/person for 2014 ($6,500 if 50 or older) A good financial advisor should know how to do this, but sadly I have discussed this strategy with several advisors over the last few years who did not know it was allowable. You can read more in our related posts – Are Roth IRA Withdrawals Taxable? and Put Your Child To Work This Summer .

Stephen Osborne, CPA
Certified Public Accountant

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