Transcript
Bo Hanson (0:06)
All right, let's do this. Next question. This is from. This is from Hayden. Hayden says, hey, money guys. Hey, Hayden, can you talk about how to prepare to do a backdoor IRA conversion? My girlfriend is nearing the limit and has a small rollover ira. I'm trying to get her to close. Ooh, there's a lot in here, Brian. I just think giving an education on what the backdoor IRA is and when it makes sense and how you execute it would be incredible.
Brian Preston (0:37)
Yeah, Hayden, first of all, tread carefully because we get you all excited. I've even. I had a really close friend. I remember last year, he sent me a text. He goes, hot dog. I'm so glad I listened to your show. And I did that back door. And I was like, whoa, whoa. I'm trying not to say his name. I was like, whoa, you. Did you get rid of that huge rollover IRA that you previously goes, no, I still have that. I was like, well, you've really. I was like, you've gotten yourself in a pickle here. Because I was like, you can't. You're going to have to prorate the basis. I mean, you're going to have to prorate this and you're going to have to pay taxes on that conversion now. And he's like, what are you talking about? And I was like, no, there's a checklist when you're going to do a backdoor Roth conversion, realize the backdoor name. I've just gone ahead and just given up and said, okay, we'll go with it, since that's what everybody in the industry calls it. But really, it's a conversion strategy is back in 2010, they ripped off the income limit on doing Roth conversions, where there used to be a cap of around $100,000 to do Roth conversions. They took it away in 2010. So now it doesn't matter what you make in income, you can convert Roth at all times. But the problem with this is that if you have an IRA rollover or a SEP IRA that you set up because you have some side hustle income or your employer doesn't have a 401, they have a simple IRA, those IRA accounts all count IRA assets. That if you did a conversion where you took pre tax money and then turned it into a Roth, you have to look at your entire basis of pre tax assets to determine the taxability of it. So that's why we always say if you go do a Roth conversion strategy, AKA the backdoor Roth, you gotta get rid of all the other IRA assets or otherwise this is not a clean strategy.
Bo Hanson (2:27)
So what, do I just cash out that ira, not pay ordinary income tax and a penalty on it?
Brian Preston (2:31)
You can go ahead and figure out, hey, okay, maybe I have a few thousand dollars, maybe I do just can pay the taxes on that Roth conversion for a few thousand dollars. Or if you have a great 401k or a great 403 that takes contributions from previous plans or even IRAs, you can roll that money, do a trustee to trustee transfer into your employer plan. And now those you no longer have IRA assets that muddy up the basis or the taxability of those Roth conversions. But don't skip the step. You've got to actually get rid of those assets first. Then you can consider making an ira, traditional IRA contribution. Since you're not typically taking a tax deduction, it's an after tax contribution into the traditional ira. And then you can convert that into a Roth. And since you didn't get a tax deduction on the contribution to the traditional ira, it's a nice little way to fund a traditional ira, not pay any income taxes except for on any earnings that traditional IRA might have made and then convert it into a Roth, it's clean as long as you go through and do your homework and make sure you don't run afoul of having other IRA assets.