October 15, 2021
Build Back Better Act – Backdoor Roths
The year-end process can be stressful for many investors and 2021 is no different in terms of having proposed changes to the federal tax code. The proposed Build Back Better Act is currently structured to limit those who can use the “Backdoor Roth” strategy and/or make Roth Conversions in general. We don’t know if this bill, in its current form, will become law, but here are some considerations.
The Backdoor Roth Strategy
The Backdoor Roth strategy is a way for high wage earners to make contributions to a Roth IRA, even if they are above the income threshold to make direct Roth contributions. The way the backdoor Roth strategy works is that an investor makes a non-deductible (after-tax) contribution to an empty Traditional IRA and then immediately makes a Roth conversion for the amount of the contribution. There is no income limit for making non-deductible contributions to a Traditional IRA and since they contributed after-tax money, there’s no tax impact on the conversion.
This is a great strategy that we recommend for all high wage earners who are already maximizing pre-tax contributions to employer plans and do not have existing pre-tax assets in a Traditional IRA.
Under current tax law, an individual with a modified adjusted gross income (MAGI) equal to or greater than $140,000 or a married couple filing jointly with a MAGI equal to or greater than $208,000 can’t contribute directly to a Roth IRA. However, anyone, regardless of their income, can use the Backdoor Roth strategy. If the Build Back Better Act is passed into law, after-tax Traditional IRA contributions will not be allowed to be converted to a Roth IRA at any income level, effective for distributions, transfers, and contributions made after December 31, 2021.
This act has not yet been passed, but we want our clients to be prepared if it becomes law. If you have any questions about the Backdoor Roth strategy or the proposed changes, don’t hesitate to reach out to your advisor or schedule a call.