If you make too much money to contribute directly to a Roth IRA, there is still a way to get funds into the plan!

Enter the Backdoor Roth IRA Conversion

The steps to complete a backdoor Roth IRA conversion are simple:

  1. Contribute to your traditional IRA

  2. Determine conversion amount

  3. Rollover/transfer/move funds to your Roth IRA (this is the actual Roth conversion)

  4. Have your CPA complete IRS form 1099-R by Jan. 31st of next year for this year's conversions

Keep in mind that converting pre-tax (traditional) IRA funds to Roth is a taxable event. Therefore, you will pay taxes on the amount of funds you are converting from pre-tax to Roth.

Backdoor Roth IRA Conversion and Getting Funds into the Roth IRA LLC

Oftentimes, the most cost effective way to do a backdoor Roth IRA conversion and then get the funds into your Roth IRA LLC is to open up a pair of "free" IRA accounts.

You can easily open a "free" traditional IRA and Roth IRA at a major brokerage firm (e.g. Schwab, Fidelity, E*Trade, Vanguard, etc). The major brokerage firms do not charge fees for converting the pre-tax (traditional) IRA to Roth, and may even file IRS form 1099-R for you. This saves you time, effort, and cost of having your CPA do the filing.

You can open a pre-tax (traditional) self-directed IRA with the new custodian who establishes your Roth IRA LLC. However, they will often charge an account opening fee, and a Roth conversion fee.

If you can use a major brokerage firm to open your (free) traditional IRA, open your (free) Roth IRA, make your tax-deductible (traditional) IRA contribution, and convert your pre-tax IRA to Roth - you may save yourself a bundle and save yourself time as well!

Roth IRA Income Limits

The IRS sets certain income limits for Roth IRA qualification. If you are above these income limits, you may not contribute directly to a Roth IRA, and instead you will need to consider the backdoor Roth IRA conversion.

Click here to view Amount of Roth IRA Contributions That You Can Make For 2019

Click here to view Amount of Roth IRA Contributions That You Can Make For 2020

Why is the Conversion Taxable?

Typically, people convert to their traditional (pre-tax) IRA because it is tax-deductible. When you convert funds from pre-tax to Roth, you are telling the IRS they don't get to charge you taxes on the Roth IRA withdrawals down the line. The IRS will always collect their due, so they charge you taxes on the conversion.

You will add the converted amount to your tax return for the year in which you are doing the conversion.

Example:

  • You decide to contribute $6,000 to your IRA for 2020 and then convert it to a Roth IRA

  • You actually move the money from the traditional (pre-tax) IRA to the Roth in February 2021

  • Add $6,000 to your taxable income for 2021 since you physically made the conversion in the 2021 tax year

Big Important Tax Calculation Disclaimer

If you have other existing traditional (pre-tax) IRA funds in your name (including traditional IRA, SEP IRA or SIMPLE IRA), you will need to work with your CPA to determine your pro-rata contribution amount/taxes. This is because the IRS doesn't want you to simply cherry pick the number you are converting - they want taxes on the portion of funds you are converting as they relate to the whole of your traditional (pre-tax) IRA funds.

An easy way around this is to convert ALL the funds you hold in your traditional IRA, though that could cause a big tax bill so proceed thoughtfully.

Alternatively, if you are simply opening the brand new traditional IRA specifically for the purposes of contributing and then converting those funds to Roth, you should be OK (but always check with your CPA of course!).

Keep your Eye on the Prize

The goal for most of us in setting up these "free" traditional (pre-tax) and Roth IRAs is to get the money quickly and easily into the Roth IRA so it can be transferred into the Checkbook Roth IRA LLC structure.

Complete the steps to open your pre-tax (traditional) free IRA and free Roth IRA. Make your contributions and conversions and then rollover/transfer those Roth IRA funds into your new Self-directed Roth IRA LLC. Then, enjoy the freedom of having your funds in your control!

Convert Traditional IRA to Roth IRA

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