Backdoor Roth IRA: A Strategy for High Earners to Invest in an IRA
Jan 19, 2024
As-Salaam-Alaikum everyone! Welcome back to Muslim Women Invest.
Today is an exciting day, because we are going to be talking about Backdoor Roth IRA conversion.
If you are unfamiliar with Backdoor Roth IRAs, if you are a high earner, and you have been given the news that you cannot invest in an individual retirement account in the United States, then keep reading. I have good news for you.
What is an IRA?
If you are unfamiliar, an IRA is an individual retirement account. Anybody in the United States is eligible to open one—yes, even kids!
In 2024, you can invest up to seven thousand dollars in an IRA. It was sixty-five hundred dollars in 2023, so it’s gone up a bit, but that seven thousand is the max you’re allowed to invest in your IRA.
Types of IRAs
There are two types of IRAs: a traditional IRA and a Roth IRA.
With a traditional IRA, you are able to invest money that has not been taxed, which means that
people who are in a very high tax bracket can put money into a traditional IRA and reduce their taxable income, lowering their tax bracket.
For people who want to invest and want their money to grow tax-free, however, the retirement account for them is the Roth IRA.
The Roth IRA is a retirement account that has an income cap. A traditional IRA, however, has no income cap.
This is where the Backdoor Roth IRA strategy comes into play, so listen carefully.
How a Backdoor Roth IRA Strategy Works
With the Roth IRA, you are only eligible to open or invest in a Roth IRA if you are making 161,000 if you're single, or 240,000 if you're filing jointly.
So how does the Backdoor Roth strategy work?
First, you open a traditional IRA and invest in that.
For example, let’s say you max out your traditional IRA. You put seven thousand dollars in that traditional IRA account, you let that money sit for two or three days, and then you’re going to convert it to a Roth IRA.
Because money in a traditional IRA is not taxed, if you convert it to a Roth IRA, you will be paying taxes on that conversion at your income tax level regardless. But once that money is in your Roth IRA, you can simply let it grow.
You can let that money sit for as long as fifty-nine and a half years, or you can access it sooner if you must.
If that surprises you, I’m not surprised—one of the misconceptions about both traditional and Roth IRAs is that people think you cannot touch that money before you're fifty-nine and a half years old.
I want to openly challenge people who say that. That is a misconception; it is a misleading statement for both the traditional and the Roth IRA. You can absolutely touch the money that you put in. The money that you cannot touch is the money that grows on top of your contributions.
If you have contributed seven thousand dollars, you can absolutely drain that money when you want it. But if that seven thousand dollars has grown to, say, eighty-four hundred dollars in the span of a year, you cannot touch the extra fourteen hundred that you have invested in that account without penalties.
You can still drain it, but the IRS will penalize you ten percent on that growth. You will also be liable to pay income taxes on it.
These are tax-deferred accounts, which means that the money inside grows tax-free, especially in the Roth IRA. But the advantages of those accounts no longer apply if you take out the money from that account. However, you can always take out your own contributions without penalty.
That’s how a Backdoor Roth IRA strategy works! If you’re curious to learn more about investing, sign up for my free weekly class now—I host this class every Sunday, and it’s a wonderful way for you to get started on your investing journey. Just like today, I do my best to explain investing in terms that are easy to understand in order to take away the intimidation surrounding investing.
Let’s get you started on your path to investing now!
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