Dear Liz: I am 65, self-employed and have a SEP IRA as well as a Roth IRA. I’ve had a few low-income years, and I find myself in a very low tax bracket, most likely lower than when I begin to take distributions and collect Social Security in a few years. What are the steps for a “backdoor Roth” conversion? As a self-employed person, do I even qualify?
Answer: A backdoor Roth is a way for higher-paid people to get around the income limit for Roth contributions. If you’re in a low tax bracket, that limit likely isn’t a problem for you.
What you’re probably asking about is a basic Roth conversion, where you roll money from your pre-tax SEP IRA into a Roth and pay the resulting taxes. Such conversions can make sense if you expect to be in a higher tax bracket later and you don’t have to tap your account to pay the taxes, but they’re not a slam dunk.
A too-large conversion could push you into a higher bracket. or increase your Medicare premiums or both. (Higher Medicare premiums are imposed when modified adjusted gross incomes exceed $88,000 for singles or $176,000 for married couples filing jointly.)
Financial planners often recommend converting just enough to “fill out” a low tax bracket. Let’s say you’re single and currently in the 12% federal tax bracket, which ends at $40,525. If your income is $25,000, you might convert about $15,000 of your SEP to avoid being pushed into the next bracket, which is 22%.
A tax pro or fee-only financial planner could advise you about how to proceed.
Michael E. Stern says
Thanks for answering my question Liz. Awesome help.
Robert says
My daughter is nearly 17 years old, makes about $2K per month and has figured out how to pay for her own college through a Masters degree without family assistance, scholarships, roommates or student loans by participating in ROTC, joining the Reserves and then making a career of the military after she gets her Bachelors degree. We are a military family. She has already been in ROTC for three years, so this is a plan she has been working on for quite some time.
Because she currently has a lot of extra money, she wants to establish a Roth IRA now to take advantage of being in a bottom tax bracket, plus 50 years or more of growth. She wants to put her money in an index fund or a exchange-traded fund.
What advice to you have for her that can get this started at a minimal cost with the potential for the best return over such a long period? Also, is there an age restriction for starting an IRA?
Liz Weston says
I love to hear about young’uns contributing to Roths! Here’s an article that might be helpful: https://www.nerdwallet.com/article/investing/how-and-where-to-open-a-roth-ira