When planning for your retirement, there are two types of independent retirement accounts (IRAs). A traditional IRA receives pre-tax income, and you are taxed when you withdraw or receive distributions later on. You are also taxed on any accumulated funds from interest and investments, as income tax is applied to any funds removed from the IRA.

A Roth IRA receives post-tax money, so withdrawals and distributions are neither taxed nor treated like income for your income tax bracket.  Many would prefer to use a Roth IRA to control tax, revenue, and earnings. Especially since you can withdraw anytime, and there are no mandatory minimum distributions after retirement age. However, with the income bracket limitation, Roth IRAs are typically unavailable to individuals or spouses with an income that is too high.

Fortunately, there is a way around it called a backdoor Roth IRA.

What Is a Backdoor Roth IRA?

A "backdoor" Roth IRA allows you to transfer the balance of a traditional IRA or 401(k) to a Roth IRA without consideration for the income level restriction. This will enable people and couples with a high-income bracket to access the financial conveniences of a Roth IRA, even if your annual income is above the restricted level.

• 2024 Roth IRA income limitations are $146,000 for single filers and $230,000 for married couples filing jointly.
• 2025 Roth IRA income limitations are $150,000 for single filers and $236,000 for married couples filing jointly.

You will pay taxes on any pre-tax funds from the traditional IRA. However, as soon as your IRA funds become part of a Roth IRA, you can manage your principal, interest, and earnings in the Roth fashion without a traditional IRA's unique limitations and requirements.

Why Pursue a Backdoor Roth IRA?

• Interest and Investment Earnings
  • With a traditional IRA, earnings from interest and investments are taxed as income when distributed because the principle is pre-tax. Once the funds have entered a Roth IRA, your earnings grow tax free.
• 5 Year Access
  • Five years after you convert an IRA to a Roth IRA, you have full access to your funds without an age or distribution limitation. If the timing is right, this can also mean earlier access to IRA funds before your retirement age.
• No Mandatory Minimum Distributions
  • A Roth IRA does not have mandatory minimum distributions, so you can conserve or withdraw as you see fit for the duration of your life.
• Lesser Tax Burden
  • In general, paying one-time taxes on IRA income converted to a Roth IRA results in a lower overall tax burden than paying income tax on the IRA distributions later on.

Tax Pitfalls to Watch Out For

One of the most important things to be aware of is the potential for mistakes when performing this complex tax-related financial maneuver. Using a backdoor Roth IRA can benefit your long-term financial planning, but you'll want to do it right and avoid possible pitfalls.

• Income Tax on Transfer
  • Remember that all pre-tax funds removed from an IRA or 401(k) will go through a tax cycle during the transfer.
• Income Bracket
  • This transfer can change your income tax bracket.
• IRA Capital Gains
  • Transfer sooner rather than later to reduce the tax burden on IRA capital gains regarding interest and investments.
• One-Time Conversion
  • The backdoor Roth IRA transfer is not a one-time thing. Continue to make routine conversions to minimize taxed earnings.

Consult With Your Financial Advisor

To get the best tax advantage and control over your retirement finances, plan your backdoor Roth IRA conversion with the help of your skilled financial advisor. We are proud to provide insight and a detailed understanding of retirement financial management to help you achieve this unique and beneficial maneuver and get the most from your retirement plans. Contact us today to explore the best financial strategies for your retirement.

Any opinions are those of Dale Crossley and Evan Shear and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions, or forecasts provided in the attached article will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including asset allocation and diversification. 

Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.

Unless certain criteria are met, Roth IRA owners must be 59 1/2 or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.