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How does a backdoor Roth IRA work?
AI accountant’s answer:
A backdoor Roth IRA is a strategy used by individuals whose income exceeds the limits for contributing directly to a Roth IRA. The process involves making a contribution to a traditional IRA and then converting that contribution to a Roth IRA. Here's a step-by-step explanation: 1. Contribute to a traditional IRA: If your income is too high to contribute directly to a Roth IRA, you can still make a contribution to a traditional IRA. There are no income limits for contributing to a traditional IRA, but the contribution might not be tax-deductible if you or your spouse have access to a workplace retirement plan. 2. Convert to a Roth IRA: After making a contribution to a traditional IRA, you can convert those funds to a Roth IRA. To do this, you'll need to contact your IRA provider and request a conversion. This process may also be known as a "Roth conversion" or "Roth rollover." 3. Pay taxes on the conversion: When you convert funds from a traditional IRA to a Roth IRA, you'll need to pay taxes on the pre-tax amount you converted. This includes any tax-deductible contributions and earnings on those contributions. If you made non-deductible contributions to your traditional IRA, you only pay taxes on the earnings portion when converting. Keep in mind that you'll need to report the conversion on your tax return and should set aside money to cover any taxes owed as a result of the conversion. Following these steps allows individuals with high incomes to access the benefits of a Roth IRA, like tax-free growth and withdrawals in retirement. However, it's essential to consider the potential tax implications and evaluate whether a backdoor Roth IRA conversion fits into your overall financial plan.
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Michael Eaton, CPA
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