Are Back Door Roth IRA’s Worth it?

Full Transcript:

These back door Roth IRAs seem complicated. Even if I jumped through all these hoops, I’m still limited to $6,500. This can’t be worth it.

Many of you watching this video make too much money to contribute directly to a Roth IRA. You may have heard of a strategy that is commonly nicknamed the back door Roth IRA, a way high earners contribute to a Roth IRA. A back door Roth IRA consists of doing a non-deductible contribution to a traditional IRA. Once it’s in your traditional IRA, you can then convert the money by transferring it to your Roth IRA. Once it’s in your Roth IRA, the money can then grow tax-free.

That’s a lot of steps, and there are potential tax consequences. So please make sure you check with your financial professional regarding your unique situation. Most people just don’t do this. It’s complicated, and they have other things they’d rather do with their time. But is it worth it? Let’s talk about the value.

Let’s assume you’re 40 years old, and at age 40, you have zero IRA balance. You have no Roth, no traditional IRAs. At this point, you say, I’m going to start with zero, and I’m going to do this back door Roth IRA. And you put this year’s limit in $6,500. Now, we’re going to also assume that you’re investing this money once you get it into your Roth IRA, and you earn an average return of 8% per year. So, as you keep doing this, the next year, at age 41, you put in another $6,500, and the money starts growing. So now you have $13,520. If we fast forward through age 50, at this point, with $6,500 contributions and the growth, you’re now up to $108,000. Now, in reality, the IRS increases the contribution limits. So, you could likely have more than this if you keep maxing out this year. We’re going to keep it at $6,500 for simplicity.

Now, at this point, let’s say you go to age 60. In order to contribute to an IRA, you just have to have some earned income. So, whether you stay at your current job until age 60 or you take a second career or a part-time side gig, as long as you have earned income, you can keep contributing. So, if you contribute through age 60, this money will have grown to $321,000. The best part is, since you’re 60 years old, you can now take that money out tax-free as you’ve passed the 59.5-year-old threshold.

All right, so you’re 60, and you say, I’m completely done working. No more earned income. I’m going to go sit on the beach, play some golf, whatever you want to do. But you also have this 401k balance and other investments. So, you decide to live off of those and let this money grow. If you let it grow another 10 years, at age 70, you will have $787,000 of tax-free money in your Roth IRA. And as this is an individual retirement account, if you’re married and your spouse does the same thing, the two of you could have one and a half million dollars of tax-free money in retirement from these two accounts alone. So, in my opinion, I fully think it’s worth it. But that doesn’t make it any less complicated.

So, I encourage you to put a system in place so that you can efficiently do this each year. For example, at New Heights Planning, our financial independence framework helps do this for each of our clients on an annual basis. Whatever system you choose, I encourage you to start today so that you can have six or seven figures of tax-free money in retirement.

Actual investment performance will vary.