Dont Make These 2 Backdoor Roth IRA Mistakes

Thinking about making a backdoor Roth IRA contribution this year? These two mistakes can cost you thousands in taxes.

Roth iras we know them we love them who can argue with tax-free growth and tax-free withdrawals for the rest of your life of course the problem is getting your money in there in the first place if you’re above the roth ira contribution income limit you won’t be able to make an annual contribution however there’s still another option on the table the back door roth

Ira contribution this is where you make an annual non-deductible traditional ira contribution up to six thousand dollars in 2022 plus another one thousand dollars if you’re 50 or older and then subsequently convert that amount to your roth ira the backdoor roth ira contribution has been a solid retirement planning tactic for years now however when dealing with

Taxes there are always rules that could come back to bite you backdoor roth ira contributions are no exception today i’m going to discuss two rules for backdoor roth ira contributions and how to avoid making mistakes that can cost you thousands and be sure to stay until the very end where i share a key component to the strategy that many people even cpas forget

Internal revenue code section 408 d2 requires taxpayers to aggregate their iras for tax purposes what does that mean in english well if you have multiple ira accounts the irs considers all of those separate iras as one account for tax purposes to be clear different types and different titled ira accounts aren’t aggregated so you wouldn’t include your spouse’s ira

Your roth ira or an inherited ira with your traditional ira accounts for aggregation purposes however you do have to include sep iras and simple iras in the total how does this aggregation complicate a backdoor roth contribution one word deductibility let’s say years ago you rolled an old employer 401k into an ira and now those assets are worth ninety four thousand

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Dollars and your excitement to begin annual backdoor roth ira contributions you’ve also funded a new and separate traditional ira account with six thousand dollars in non-deductible contributions because of the account aggregation rule the irs considers your two iras as one account for tax purposes totaling one hundred thousand dollars six thousand dollars of

That being non-deductible contributions so what happens when you try to make a roth ira conversion on the six thousand dollars in your second ira unfortunately part of it is subject to income tax because the accounts are aggregated only the pro-rada share of non-deductible ira assets would be considered a tax-free roth conversion in this case only six percent of

The conversion would be tax-free so instead of a properly executed backdoor roth ira conversion only 360 dollars would be converted without taxes udo ordinary income taxes on the remaining five thousand six hundred and forty dollars that’s not the result we’re looking for so how do you avoid this mistake well simply knowing about the ira account aggregation rule

Helps if you have multiple iras annual backdoor roth ira contributions may not be a tactic that’s available for you however if you have ira assets and a decent employer retirement plan you might have an option you may want to consider rolling your ira into your active 401k plan if it accepts roll-in contributions 401ks have different rules and are not included in

Ira account aggregation strangely after tax non-deductible ira assets are not allowed to be rolled into an employer retirement plan under section 408 d3a2 so the ira account aggregation rules don’t apply in that case who knew that there’d be an inconsistency in the tax law right once you’ve moved your ira into your 401k the backdoor roth ira contribution strategy

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Is back on the menu however there’s another rule that could come up to bite you the step transaction rule essentially treats a series of discrete steps as a single transaction if taken together the steps are intended to produce a particular result because of backdoor roth ira contribution has multiple steps focused on a particular result it could potentially be

Considered a step transaction and disallowed by the irs if you’re considering funding your roth ira in this manner there are some best practices that you should follow first allow time to pass between each step in the process you could always buy your target investments with the non-deductible ira contributions and convert them in kind later independently each of

These steps is permissible so the goal is to establish that each step really is separate unfortunately there are no rules on how long to wait between transactions somewhere between a month and a year should work depending on how conservative you want to be with this strategy some tax experts stand by the one statement rule if you wait at least long enough to get a

New monthly statement from your account you’ll be okay in addition if you invest the funds between steps there’s a small chance that you’ll create a small tax liability when you convert for instance if your six thousand dollars grows to sixty five hundred dollars the five hundred dollars in gains will be taxable when you convert a little growth isn’t bad and it could

Also be used to prove that it wasn’t a step transaction next do not keep notes about using backdoor roth ira contributions or discuss it in written communication with your financial advisor or cpa this kind of communication is discoverable and could potentially be used against you in tax court if you’re planning to make a backdoor roth ira contribution this year

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Be sure to get your professionals involved early if you wait until late december you may not be able to get it done in time the big account custodians and brokerage houses have started closing the window on year-end transactions earlier and earlier over the last few years finally there’s one more mistake to avoid when making backdoor roth ira contributions

Forgetting to file form 8606 form 8606 specifies that your initial traditional ira contribution was indeed non-deductible and therefore your subsequent roth ira conversion was non-taxable where i see this issue come up the most is when someone does all this work themselves and then forgets to tell their cpa about the non-deductible contribution it’s an easy one

To forget if you’re interested in more retirement planning help i recommend that you watch this video to learn more thanks for watching and i’ll see you in the next video

Transcribed from video
Don’t Make These 2 Backdoor Roth IRA Mistakes By Prana Wealth