Changes To Social Security Will Take Away Some Key Planning Strategies That Couples Used To Boost Their Total Benefits
As part of recent negotiations between Congress and the White House over the budget, major…
If your income is too high, you can’t contribute directly to a Roth individual retirement account, but you can get one in a “backdoor” way.
Step 1: Open a traditional IRA (in your case, it’s nondeductible).
Step 2: Convert it to a Roth IRA. Is it worth it? “It’s a no-brainer if you have the cash to do it,” says Kevin Huston, an enrolled agent in Asheville, N.C. who has clients both young and old doing it to shore up their retirement savings. “It especially makes sense for people who are younger because they have all these years of tax-free growth,” he says.
Basically, you get an extra $5,000 (or $6,000 if you’re 50 or older) each year that grows in the Roth IRA income-tax free. That’s $10,000 (or $12,000) a year for a married couple. Repeat each year, and you can amass a nice retirement kitty. The audience for backdoor Roths is a niche, appealing to those earning too much to contribute to Roths directly but not so much that the extra tax savings doesn’t seem worth the effort. Vanguard says that “backdoor Roth” contributions represented about 2 percent of traditional IRA contributions in 2011. (Income restrictions on conversions were lifted starting Jan. 1, 2010, so anyone—regardless of income—can convert a traditional IRA to a Roth.)
Why go through the hoops of getting money into a Roth IRA? They are an amazing deal, especially for folks looking long-term and expecting higher tax rates in the future. With a Roth IRA you don’t ever have to take money out, and when you do start taking money out, it’s all income-tax-free, including the earnings. By contrast, with a traditional IRA, earnings grow tax-deferred, you have to start taking required mandatory distributions the year after you turn 70.5, and distributions count as income. A Roth can help keep your tax bite down in retirement. (Ideally you want a mix of taxable, tax-deferred and tax-free accounts to draw from in retirement.)
For an example of how one couple is using this strategy to build their nest egg and a more complete analysis, visit the link “The Serial Backdoor Roth, A Tax-Free Retirement Kitty” at Forbes.com.