What is a Backdoor Roth IRA Conversion? - Medicare Life Health (2024)

FAQs

What is a Backdoor Roth IRA Conversion? - Medicare Life Health? ›

A backdoor Roth IRA is a conversion that allows high earners to open a Roth IRA despite IRS-imposed income limits. Basically, you put money you've already paid taxes on in a traditional IRA, then convert your contributed money into a Roth IRA, and you're done.

If a Roth conversion were to increase your taxable income, then more of your Social Security benefits would be taxed and your Medicare costs could rise. You don't have money to pay the conversion tax or must sell assets that could lead to an additional tax hit.

So, does a Roth conversion count as income for Obamacare? Yes, it does! You need to decide if the future tax savings from Roth conversions make up for the loss of Obamacare tax credits.

Cons: All or part of a backdoor Roth IRA conversion could be a taxable event. You may have to pay federal, state, and local taxes on converted earnings and deductible contributions. Conversions could kick you into a higher tax bracket for the year.

A backdoor Roth is a loophole that avoids income limits to be eligible to contribute to a tax-free Roth IRA retirement account. The loophole: Taxpayers making more than the $161,000 limit in 2024 can't contribute to a Roth IRA, but they can convert other forms of IRA accounts into Roth IRA accounts.

Since a Roth conversion increases taxable income in the conversion year, drawbacks can include a higher tax bracket, more taxes on Social Security benefits, higher Medicare premiums, and lower college financial aid.

While there's no prohibition or disadvantage to a Roth conversion based on your age at 65, converting the entire $1.2 million all at once will burden you with a larger tax bill than you may want to pay in a single year.

The amount you convert from a traditional account to a Roth account is treated as income—just like all taxable distributions from pretax qualified accounts. Therefore the conversion amount is part of your MAGI, and it may move you above the tax's thresholds.

For example, 2023 IRMAA premiums are based off your 2021 MAGI. Therefore, if you complete a Roth conversion this year (2023), it won't impact your IRMAA until two years from now (2025). Read our Shakespeare blog, How Income Impacts Medicare Premiums, for additional specifics on IRMAA.

There is no loophole to make the conversion not count as part of your Modified Adjusted Gross Income. The thing you can do, if you are having to pay back a large amount, is apply for a payment plan to not have to pay it all at once.

Who cannot do Backdoor Roth? ›

Backdoor Roth IRA income limits

The phaseout occurs between $146,000 and $161,000 for single filers and $230,000 and $240,000 for joint filers in 2024. The backdoor method allows those with higher incomes who can't contribute in the typical manner to still take advantage of a Roth IRA.

You won't pay double taxes with a backdoor Roth, but you may end up paying some taxes depending on your financial situation. Talk with your financial advisor before making this move to minimize taxes and maximize retirement benefits.

The Roth IRA five-year rule says you cannot withdraw earnings tax-free until it's been at least five years since you first contributed to a Roth IRA account. This five-year rule applies to everyone who contributes to a Roth IRA, whether they're 59 ½ or 105 years old.

However, there are no limits on conversions. A taxpayer with a pre-tax IRA can convert any amount of funds in a year to a Roth IRA. Roth IRAs also are exempt from required minimum distributions (RMDs). These mandatory withdrawals from retirement accounts begin at age 72 and can create a tax burden on affluent retirees.

Taxes aren't due until the tax deadline of the following year, so you may have more than 15 months to pay the taxes on your converted balances. (Note: If you pay estimated taxes, you may need to make some payments sooner.)

The amount you convert from a traditional account to a Roth account is treated as income—just like all taxable distributions from pretax qualified accounts. Therefore the conversion amount is part of your MAGI, and it may move you above the tax's thresholds.

Roth conversions won't affect the calculation of your Social Security benefit that you're eligible to receive, but they can impact whether you pay taxes on your benefit – and how much.

Because Roth IRA conversions add to your income for the year, it's quite common for the conversion to be the root cause of an IRMAA if proper planning does not take place.

For example, 2023 IRMAA premiums are based off your 2021 MAGI. Therefore, if you complete a Roth conversion this year (2023), it won't impact your IRMAA until two years from now (2025). Read our Shakespeare blog, How Income Impacts Medicare Premiums, for additional specifics on IRMAA.