The Backdoor Roth IRA: What Federal Employees Need To Know

The Backdoor Roth IRA- What Federal Employees Need To Know

A common question I get from highly motivated savers is whether they can contribute to their Roth TSP and a Roth IRA each year.

And while having a TSP does not prevent you from having a Roth IRA, if your Modified Adjusted Gross Income (MAGI)* is too high, you will be ineligible to contribute to a Roth IRA.

For tax years 2021 and 2022, if your tax filing status was MFJ and your MAGI exceeded $208k and $214k, respectively, you were not allowed to contribute to a Roth IRA.

Fortunately, the Backdoor Roth strategy gets around this rule legally, allowing you to contribute to a Roth.

So, this week we are diving into what federal employees need to know about the Backdoor Roth!

Roth IRA MAGI Phase-out Ranges for 2022 and 2021

What Is A Backdoor Roth IRA?

As previously mentioned, the Backdoor Roth is a strategy for funding a Roth IRA when your income exceeds the threshold; it is not, however, a specific IRA account type.

This strategy involves either converting an existing traditional IRA or opening a traditional IRA for the sole purpose of making nondeductible contributions and then immediately transferring those contributions into a Roth IRA.

The financial institution holding your IRA should be able to help you with the mechanics. Also, make sure you file Form 8606 to report the conversion and any nondeductible contributions when you file your income taxes.

Advantages Of The Backdoor Roth

If you earned too much to contribute to a Roth IRA, you might want to utilize this strategy for the following reasons:

  1. Tax Advantages: You’ll eventually be able to withdraw your funds tax-free. This can be especially advantageous if you expect to be in a higher tax bracket in retirement.
  2. No RMDs: Unlike traditional IRAs, Roth IRAs are not subject to Required Minimum Distributions (RMDs) at age 72.
  3. Can Limit The Taxes Paid On Social Security: Your Social Security benefits will be taxed on a range from 0-85%, and where you land on that range depends on your provisional income. As a federal employee, you’ll have a pension and might be taking TSP distributions in retirement; thus, you can easily surpass the provisional income thresholds. So, having tax-free income from a Roth IRA can help you avoid exceeding these limits. You can read more about how your Social Security will be taxed here.

Disadvantages Of The Backdoor Roth

  1. Tax Bill: Converting an existing traditional IRA means you’ll be footing the bill for the amount transferred. Therefore, be cautious before converting a large amount as it can push you into a higher tax bracket and result in a large tax bill.
  2. Five-Year Waiting Period: The funds transferred to the Roth are considered converted funds, not contributions. Meaning they are subject to a five-year holding period before they can be withdrawn penalty-free and their earnings penalty and tax-free.

Final Thoughts

If you’re considering the Backdoor Roth IRA, crunch the numbers and weigh the pros and cons, especially when converting a large existing account.

Although this can be a lucrative strategy in the long run, it requires ongoing attention to detail and knowledge of the rules.

So, if you are not absolutely confident about your knowledge of the Backdoor Roth IRA, consult a qualified financial planner that can help you run through the tax implications.

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2023 Legislative Change Notice

The SECURE ACT 2.0 passed and impacted many of the articles on this website. While the articles were correct when written, it’s impossible to re-write every article. Please consult a qualified professional (i.e., CFP®, CPA, or attorney) before implementing any strategy.

Published by Jose Armenta, MsBA, CFP®, ChFC®, EA

Jose Armenta is a CERTIFIED FINANCIAL PLANNER™ professional who specializes in helping federal employees get the most out of their federal benefits. Jose’s experience serving federal employees has provided him with valuable insight into federal employees' unique financial planning needs.

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