Time For a Roth IRA?

You can sum up the appeal of a Roth IRA in three words: federal tax benefit. Potential earnings in a Roth IRA grow tax free as long as the owner abides by the Internal Revenue Service (I.R.S.) rules, and withdrawals are federally tax free once you reach age 59½ and have held the Roth IRA for at least five years.1

Unfortunately, some people make too much money to contribute to one. In 2020, joint filers with modified adjusted gross incomes (MAGI) of $206,000 or more and single filers with MAGI of $139,000 are not eligible for a ROTH IRA.

There is a way for high earners to bypass these limits, however: the “backdoor” Roth IRA strategy.2

High-income taxpayers may create Roth IRAs indirectly. This involves a little maneuvering, but may be of interest to certain investors.

The “backdoor” IRA strategy typically starts with the creation of a traditional IRA. The contributions to this new IRA are usually non-deductible, because of the IRA owner’s high modified adjusted gross income. This new traditional IRA is fully or partly funded, and with a financial professional’s help, it is quickly converted to a Roth IRA, and any tax liability is paid.3

Why does speed matter in this strategy? Well, the longer it takes to convert the traditional IRA into a Roth IRA, the greater the potential earnings of that traditional IRA. Since any traditional IRA earnings converted over to the Roth represent taxable income, those earnings should be minimal if the transfer is completed shortly after…