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Roth Conversions vs. the Backdoor Roth IRA

Roth conversions versus the Backdoor Roth IRA. Everyone, hello. This is Adam Bergman, a tax attorney and founder of IRA Financial. In today’s video, I’m going to explain to you everything you need to know about doing a Backdoor Roth IRA or a Roth conversion. Are they the same? Are they different?
Beginning in 2010, there are no income limitations for Roth conversions, meaning anyone, whether you’re Jeff Bezos, Warren Buffet, if you want to do a Roth conversion, you can. Why is 2010 relevant? Well, we didn’t know it happened before 2010. There was a financial crisis. The government needed money. They said, hey, what’s a great way to entice people to pay taxes prematurely? Roth conversions. Why? Because of a Roth conversion, you basically take your pre-tax IRA, and convert it to Roth. The amount you convert is subject to ordinary income tax. So, it’s a great way to accelerate tax-free. Now, as an investor, I love the Roth IRA because once I’m 59.5, the Roth has been open for at least five years, it’s all tax-free.
Once you pay the conversion, I’m in a Roth world now. So long as I’m 59 and a half, the Roth has been open for at least five years, I can pull everything out of the Roth IRA tax-free. If I pass, my spouse will get the Roth IRA tax-free. She can use the money, or he can use the money tax-free. When they pass the non-spouse heirs, kids, for example, have 10 years to use the Roth IRA funds tax-free. It’s a great tax planning tool. It’s not a tax deduction, but so long as you can preserve the Roth value, 59.5, Roth is open for five years, it’s all tax-free. That’s what a Roth conversion is. And like I said anyone can do a Roth conversion now.
A Backdoor Roth IRA is a little bit different. It uses the principles of a Roth conversion. It just is used for a different reason. The Backdoor Roth IRA is used for someone who makes $240,000 or more in married, filed jointly in 2024. It’s about 161K if you’re single. So, if you make more than 161K if you’re single, you technically can’t do a Roth IRA. If you make more than $240,000 married, and file jointly, you technically can’t do a Roth IRA.

 But here’s the but. Remember I said, in 2010, they got rid of income limitations for Roth conversions. So, what’s the trick? The trick is this. You set up an after-tax IRA. It’s a traditional IRA. You just don’t claim a tax deduction. You put in up to 7K or 8K for over 50, 2024, 6,500, or 7,500 for ’23, which you have until April ’15 to do. And because it’s after-tax, you don’t get a deduction. But after-tax to Roth conversions are tax-free, right? Because it’s after-tax money. And since 2010, anyone can do conversions. So now the Backdoor Roth IRA, what has it done? It allows someone who makes more than $240,000 married, filed jointly, or 161 single into a Roth when without that strategy, they would not have been able to do a Roth contribution. It uses the principles of a conversion, but it’s really used to make Roth contributions of seven or 8K in ’24 or 6,500 or 7,500 in ‘2023. Now, one thing to keep in mind is if you have other traditional pre-tax IRAs outstanding, there is a pro-rata formula to determine how much of that back a Roth IRA can go tax rate.
Here’s a simple example that explains this instance. Let’s say you have a $5,000 pre-tax IRA from prior years, and you want to do a $5,000 Backdoor Roth IRA in 2024. The way it works is you can’t do the full 5,000 tax-free because you have this other pretax IRA. So, this pro-rata formula is pretty simple. You take all the IRAs, add them together. Five and five is 10 in this example, of course. And then the 5,000 Backdoor divided by 10, that’s 50%. Meaning 50% of the $5,000 I want a Backdoor to Roth this year, 50% could be tax-free, Roth. 50% would be taxable because it would be attributable to the other previous traditional IRA. It’s just a rule. 401(k)s don’t matter. It’s only if you have pre-tax IRAs. That’s only if you’re doing the Backdoor Roth IRA. It doesn’t apply to Roth conversions. Roth conversions, you could pick what you want to convert. Cash is cash. If you want to convert assets like real estate or stocks, it’s based off the fair market value. That, in a nutshell, is how the Roth IRA conversion works. Again, no income limitations. Anyone could do it. You just have to pay ordinary income tax, pay fair market value of what you’re converting.
The Backdoor Roth IRA is a strategy that uses the conversion that helps you circumvent the income limitations for Roth contributions and allows you to make Roth contributions, even if you make more than the income limitation of $240 or $161 if single in 2024. That’s it.
Hope you guys enjoy the video. Hope this was interesting. I get this question a lot, Roth Conversions, Backdoor Roth IRA. So hopefully now you get it. Don’t forget to subscribe to this amazing channel. It’s so much fun. I put a lot of effort in, so I hope you guys enjoy it. It’s free. What are you waiting for? Also, we generally drop three to four to five videos a week. I go live once a week, so definitely make a reference to try to get notifications when new videos get posted. This way you can figure it out if you’re bored or you want to watch it, but at least you’ll know, or you can just go to the channel and check it out. But subscribe. And if you have a comment, please, please leave it. I love hearing from all of you. That’s it for today. I hope you guys enjoyed the video.
And please, please, please check out all my other really, I think, super interesting videos on various Self-Directed retirement topics. Thank you, and I hope to see everyone again in my next video.

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