3 Things To Know About Roth Backdoor IRAs Personal finance
3. The IRS uses the pro rata rule
After you create a Roth IRA backdoor, the IRS will calculate the exact amount of your tax bill on a pro rata basis, that is, on a pro rata basis. First, they will look at the amount of your Traditional IRA. Because it’s possible to have multiple traditional IRA accounts, they look at the sum of all of your accounts, not just the one you may be using to convert. Then they look at how much of that amount is pre-tax versus the after-tax contributions. Regardless of the percentage of your account (s) before tax, it is the same percentage of money converted to Roth IRAs that you will owe taxes on.
For example, if 80% of the money in your Traditional IRA is pre-tax, 80% of the money converted to a Roth IRA will be taxable – and there is no way to convert only after-tax money. If you converted $ 100,000, you owed income tax on $ 80,000.
Who should benefit from Roth IRA backdoor
Roth backdoor IRAs usually only make sense for people whose income exceeds the income limit. If you’re below the income threshold, you can save yourself the effort (and tax implications) of IRA conversions by simply contributing directly to a Roth IRA. If you are above the income threshold, the process of setting up a backdoor Roth IRA may be worth it, especially since Roth IRAs do not have minimum distributions required and accounts can grow. tax free as long as they’re reopened.