IRA Backdoor Roth IRA – How to Convert a Traditional IRA to a Roth IRA Tax-Free

Backdoor Roth IRA – How to Convert a Traditional IRA to a Roth IRA Tax-Free

backdoor roth fidelity step by step

If you’re not eligible to contribute directly to a Roth IRA because you’re above the income limits, there is an indirect way to grow your money tax-free. It’s called a backdoor Roth.

The strategy involves contributing to a traditional IRA, then converting it to a Roth IRA. This is often the easiest option, but it’s not a good idea if you’re in a high tax bracket.

1. Contribute to a Traditional IRA

A Traditional IRA is a great place to save for retirement because it can be tax-deferred. This means you won’t have to pay taxes on any gains that grow in your IRA account until you take withdrawals from it in retirement.

You can contribute to a Traditional IRA regardless of your employer’s plan status or whether you have taxable income. Those with incomes below certain levels, such as $90,000 for couples or $56,000 for singles, are eligible for fully deductible contributions.

Those with higher incomes may not be able to deduct their IRA contributions or they may be phased out of the deduction depending on their MAGI and filing status.

Using this backdoor Roth strategy, you can contribute to your Traditional IRA and then convert it to a Roth IRA without paying any taxes. However, it is important to be aware of the risks involved and to have a good understanding of IRS documentation requirements before you make this conversion.

2. Convert the Traditional IRA to a Roth IRA

Many people who make too much to contribute to a traditional IRA can use a backdoor Roth IRA strategy. This involves contributing to a nondeductible traditional IRA before converting that money into a Roth IRA.

The resulting amount is tax-free as long as it remains in the account.

But before you do, consider your tax bracket and if you can afford the additional taxes. Talk to your financial advisor to determine if this is the right decision for you.

The best time to convert is when your income has decreased because of job loss, pay cuts or other circumstances that lower your tax bracket. It’s also a good idea to convert before age 59 1/2 because you’ll be able to access your tax-deferred savings penalty-free later on, as long as you have enough Roth funds to last you through retirement.

3. Transfer the Traditional IRA to Fidelity

IRAs are a great way to save for retirement. They offer tax-deferred growth and tax-free withdrawals later in life.

Traditional IRAs are a popular choice amongst investors, as they provide a variety of investment options that let you achieve virtually any risk-return profile you desire. These include stocks, bonds, alternative investments and fund-style vehicles that combine a number of asset types.

If you have an IRA account with another financial institution, you may want to transfer it over to Fidelity. This is called a trustee-to-trustee transfer and is the easiest type of rollover.

You can transfer your IRA to Fidelity by opening an account at the new institution and completing the required paperwork. Once the IRA provider accepts the transfer, they will close your existing account and send you a check. Make sure to deliver the check to the new IRA institution within 60 days of issue to avoid taxes and penalties being withheld.

4. Convert the Fidelity Traditional IRA to a Roth IRA

Fidelity makes it easy to convert a portion of your traditional IRA to a Roth IRA over several years. That way, you can spread out the tax payments and potentially lower your taxable income during retirement.

This strategy can be particularly beneficial if you intend to leave your money to your heirs, as it could help minimize your estate taxes and increase the amount of your assets that aren’t taxed. It may also make sense to do a conversion if you’re experiencing a low income in the year of the conversion.

A Roth IRA allows for tax-free growth and withdrawals in retirement. However, it comes with certain tax costs and a requirement to have held the account for five years before you can withdraw your funds. If you don’t follow these guidelines, the IRS will impose a 10% penalty on any amount you take out of your Roth IRA before age 59 1/2.