A backdoor Roth IRA can be on a tight block. Here’s what you can do now

If the Build Better Again bill, which passed the House of Representatives in November and is currently under consideration by the Senate, becomes law, it could limit the options of high-income savers to convert. their savings into a Roth IRA and a Roth 401(k), which provide tax-free withdrawals in retirement.

The most immediate restriction, unless lawmakers amend the date, will begin in 2022, when you’re no longer allowed to convert after-tax contributions — such as from a non-deductible IRA — into Roth .

Converting to Roth will allow your funds to not only grow tax-free, but also allow you to withdraw tax-free. Having that option would make sense if you want to stay in a higher tax bracket in retirement or if you want more flexibility to decide when to use different funds for different purposes in retirement or any other time.

Since the law has yet to change, high-income savers can still take steps to maximize their 2021 Roth options.

Congress wants to destroy & # 39;  backdoor Roth IRA.  & # 39;  Here's what it means to you

You can contribute up to $6,000 (or $7,000 if you’re at least 50) into a Traditional or Roth IRA. But if your adjusted adjusted gross income is $140,000 or more ($208,000 if filing jointly), you can’t contribute directly to Roth in 2021. And if you’re covered by a retirement plan at work and your income is $76,000 or more ($125,000 if married), you can’t either. deductible contributions to a traditional IRA.

However, in either case, you can make after-tax contributions to a traditional IRA. And then you can instantly roll those contributions into a Roth IRA.

While you can technically contribute to 2021 by April 15, 2022, conversions must be made – or at least in processing – by December 31 to calculated for this year, before any potential restrictions go into effect, California said – based on the Mary Kay Foss public accountant credential.

But usually, a conversion can be done in a day or two. “It’s very fast,” Foss said.

Tax reduction

The immediate pitfall, however, is that you’ll probably owe the least tax part of the amount you convert – even if all you convert is your after-tax contribution.

To determine how much tax you will owe on your after-tax contributions, the IRS uses the pro-rated rule, calculate what you are converting as a percentage of all your IRA balances.

How much do I need to save for retirement?

Here’s how it works: Let’s say you’re 51 years old and earn $7,000 after taxes This year’s IRA contributions are not deductible, but you also have pre-tax traditional IRA savings of $63,000. According to the rule of thumb, the after-tax ($7,000) represents 10% of your total IRA savings ($70,000). So when you convert this year’s contribution to Roth, only $700 will be tax-free; you will owe income tax on another $6,300. And you’ll have to pay that tax by April 15, 2022.

While that may sound like double taxation, it’s technically not going to happen because the rest of your after-tax contributions will ultimately reduce the taxes you pay. when you withdraw taxable money in retirement. “The remaining basis from your unlimited IRA contributions is taken into account when you make future IRA withdrawals. This amount is not lost forever,” Foss said.

And of course, if you’re also converting pre-tax IRA savings to Roth, you’ll also have to pay income tax on those.

There is a way to avoid the rate rule. If your employer allows you to roll your IRA savings into your 401(k) and you are able to do so by December 31, you won’t have any other IRA savings, in effect, in addition to a $7,000 after-tax contribution for 2021 to convert. So in that case, 100% of your conversion to a Roth IRA this year will be tax free.

Get helpful advice before you act

The specifics of your situation maybe more more complex examples above. And the IRS rules governing different types of IRAs — especially Roths — are complicated, and never more so when you’re transferring money from one place to another.

This is one of the best ways to get tax-free retirement savings

This is also the case if you are thinking of converting your after-tax savings in your qualified retirement plan at work into a Roth 401(k), if your employer offers an after-tax voluntary contribution option. The advantage of Roth 401(ks) over Roth IRAs is that there are no income eligibility requirements and you can contribute much higher amounts annually. As with the Roth IRA, the restrictions on the Roth 401(k) will go into effect early next year under the Build Back Better bill that passed the House if it becomes law.

So, before making any move, consult a savvy retirement and tax consultant who can guide you through your options and help you think through the tax consequences. both now and in retirement.


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