Is the Back-Door ROTH soon to be Out the Door?
On September 13, President Biden and Democrats released a comprehensive proposal that if enacted would impact
almost all areas of tax planning. For now, this is just a proposal, but there are some things you can do before the end
of the year to make sure you are taking advantage of planning strategies that may not be available next year.
Most items in the proposal will impact higher-income taxpayers. However, there are a few items in the language
that would impact some smaller earners as well. Notably, the popular back-door ROTH IRA. Below we will outline
what the Back-Door Roth is, what changes are being proposed, and how you can act quickly to take advantage of
how the law is written today.
What is a Back-Door ROTH?
The backdoor ROTH IRA is one of the most common planning techniques for advisors and their clients. For 2021, the
current threshold on income for ROTH IRA accounts is $208,000 for couples filing jointly ($140,000 for single filers).
The only way higher-income earners can fund a ROTH IRA is to use “the Backdoor.” Here’s how it works. First, you
fund your IRA account with after-tax dollars. Once those funds are in your traditional IRA, you convert those
contributions to a ROTH account. At Compass, we convert our contributions as soon as possible so that clients pay
little or no taxes on the conversion because the after-tax contributions to the IRA have already been taxed. If there
has been any appreciation on the after-tax contribution to the IRA, taxes will be owed. Please be aware that there
are pro-rata rules that need to be followed if your IRA currently consists of both tax-deferred contributions and
What is changing?
The current proposal on the table would not allow conversions of after-tax dollars in IRAs starting in 2022. This
would eliminate the ability to use the Backdoor ROTH strategy. It is important to note that the current proposal only
would eliminate the ability to convert after-tax dollars to ROTH IRA accounts. You would still be able to do
traditional ROTH conversions, in which you are converting pre-tax dollars to a ROTH IRA and paying ordinary
income on the amount converted.
What can you do?
If you have already been making Back-Door Roth conversions in the past, we would recommend making sure to do
one this year because the strategy may not be available next year. For 2021, you can make an after-tax contribution
of $6000 ($7000 if you are 50 or older) and convert that amount to a ROTH IRA paying little to no taxes. Also, if you still have after-tax contributions sitting in traditional IRAs, it could make sense to convert those dollars to ROTH IRAs while it is still allowed under current law.
As always, please consult with your tax advisor before making any changes that could impact your tax liabilities. If
you would like more information on Back-Door ROTHs or other planning strategies, please reach out to us.
VISIT OUR WEBSITE AT COMPASSAWEALTHMANAGEMENT.com COMPASS WEALTH MANAGEMENT LLC • 10 Water St. Guilford, CT 06437 • (203) 453-7000 Compass Wealth Management LLC is a SEC registered investment advisor, clearing transactions primarily through Pershing Advisor Solutions and Pershing LLC subsidiaries of Bank of New York Mellon Corp. This letter is written by Compass for the benefit of its clients and does not necessarily represent the opinions of its affiliated organizations. It is based on information believed to be reliable, but which is not guaranteed to be correct. Nothing herein shall be construed to be a solicitation to buy or sell securities, indicate that past performance is predictive of future returns, or recommend individual investments.