Backdoor Roth Update

Take-Away: While pursing a backdoor Roth IRA contribution is still ‘legal’ you may want to think twice before engaging in that type of planning transaction.

Background: A backdoor Roth IRA strategy permits an individual to make an indirect Roth IRA contribution if the individual’s income is too high to qualify for a direct contribution to a Roth IRA.

– Income Phase-Outs: In 2022, the income phase-out ranges from $204,000 to $214,000 for married couples who file jointly, and $129,000 to $144,000 for single individuals.

– Conversion Steps: The backdoor strategy requires the individual to make a contribution to a traditional IRA and then convert that IRA to a Roth IRA. This permits a $6,000 to $7,000 contribution (if there is earned income or compensation) to a traditional IRA, to be converted, each year, into a Roth IRA.

– Mega Backdoor: An individual can use a mega backdoor Roth by making an after-tax contribution to a 401(k) account and then converting that contribution into a Roth IRA. However, many qualified plans do not allow an after-tax contribution. For those qualified plans that do permit permit an after-tax contribution, a mega backdoor Roth thus permits a much larger amount that can be contributed and then converted than with a conventional annual IRA contribution.

2017 Tax Act: While there was some question if a backdoor Roth conversion was permissible prior to the 2017 Tax Act, that Act explicitly endorsed the use of backdoor Roth IRA conversions.

Build Back Better Proposed Act: This proposed legislation, passed in 2021 by the House in November 2021, , but stalled in the Senate, would have expressly eliminated both the backdoor Roth IRA conversion and also the mega backdoor Roth strategy for converting after-tax contributions to a qualified plan.

Planning Point: Since the Build Back Better Act (BBB) did not become law, arguably both a backdoor Roth IRA conversion and a mega backdoor Roth conversion strategy are still viable planning techniques to save for retirement.

Planning Caution: While these backdoor are currently legal planning strategies, the adoption of the Build Back Better Act by the House of Representatives is a strong indication that these backdoor strategies might not be available much longer. Consider the fact that there was not much controversy about their elimination back in November when the House passed its version of the proposed legislation. Also, as we learned all throughout 2021, it is possible for Congress to constitutionally pass tax legislation and make the changes retroactive. If the BBB Act is finally adopted (or a somewhat watered down version of it that is acceptable to Senator Manchin) then those individuals who performed a backdoor Roth IRA conversion early in 2022, prior to when BBB became the law, their contributions would be treated as excess Roth IRA contributions subject to penalty.

Conclusion: While these backdoor Roth conversion strategies are still legal, engaging in one at this time brings with it considerable risk. Individuals who are interested in pursuing a backdoor Roth conversion need to be fully aware of the risks doing so.