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backdoor IRA

Q&A: Backdoor Roth Ira conversions

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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.

Q&A: Backdoor Roth IRA contributions

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Dear Liz: You mentioned in a previous column that a backdoor Roth contribution could be expensive if you have a large pretax IRA. I was in that situation, and opted to first roll my IRA into my employer’s 401(k). I then made a nondeductible contribution to a new IRA and shortly afterward converted it to a Roth. This allowed me to get money into a Roth without a big tax bill.

Answer: That’s a great solution for those who have access to 401(k) plans that accept such transfers, and many do.

For those who don’t know, backdoor Roths are a two-step process for people whose incomes are too high to contribute directly to a Roth. Instead, they contribute to a regular IRA and then convert that money to a Roth because there’s no income limit on conversions.

Taxes are usually owed on Roth conversions, based on how much pretax money you have in IRAs. But the conversion can be tax free if the contribution was nondeductible, you convert shortly after the contribution and you don’t already have a pre-tax money IRA.

Some questioned the legality of this particular loophole, but Congress blessed it in 2017 as part of the Tax Cut and Jobs Act of 2017.