﻿In the year 2022, if your combined family income is above $214,000, I have some bad news for you.
You can no longer contribute to a Roth IRA. Hi, if you are new to the channel, my name is Tae
from Financial Tortoise. Where we learn to grow our wealth, slow and steady. Yes I know. This
is definitely a first world problem. A problem of making too much money that you can’t take
advantage of tax advantage accounts like a Roth IRA. In 2022, a modified adjusted gross income
(MAGI) of $214,000 for a couple filing jointly, or $144,000 for an individual, makes you ineligible
to contribute to a Roth IRA. Phaseout ranges where you can make a smaller Roth contribution,
less than $6,000, start at $204,000 for married filing jointly and $129,000 single filers. If
there is a chance that your income might be in these phaseout ranges, I highly recommend using
a Backdoor Roth IRA. A completely legal way to continue to fund your Roth IRA regardless of your
income level. I’ve broken this video into three sections, so feel free to skip around. First,
we’ll deep dive into Roth IRA and Backdoor Roth IRA specifically. What it is and why you should
consider doing it. Second, I’ll walk you step by step on how to do this correctly. I’m going to
show it through Vanguard since this is where I hold my Roth IRA, but the steps are pretty much
the same with any other firm. And following the steps are very important so you are in accordance
with Internal Revenue Services’ requirement around this process. And Third, I want to share with
you a few of the most common Backdoor Roth IRA errors to avoid so you don’t make them yourself.
First, let’s talk about the Roth IRA. A Roth IRA allows individuals to set aside
several thousand dollars from their earnings every year in a retirement savings account. For 2022,
the max is $6,000 per individual. And unlike a Traditional IRA, the money contributed into a
Roth IRA is after-tax dollars. With Traditional IRA, the earner receives immediate deduction for
their contribution, but pays tax when money is withdrawn on dollars invested and their
earnings. With Roth IRA, the earner pays taxes upfront, but taxes are not owed on the earnings or
dollars invested during withdrawal. For those who don’t want to worry about taxes in later years,
Roth IRAs are a great way to do that. However, a problem occurs for high-income earners when they
start earning above a certain threshold. They can’t open or fund Roth IRAs if a couple filing
jointly has a modified adjusted gross income of $214,000, or $144,000 for an individual.
Traditional IRA on the other hand do not have income ceiling for participation.
And the Internal Revenue Service also doesn’t have income limits that restrict who can convert
a traditional IRA to a Roth IRA. As a result, this Backdoor Roth IRA has become a tax planning
opportunity for many high income earners, who previously couldn’t contribute to Roth IRA.
Now the question you might be asking is. Is this worth the trouble? It feels like a lot of work
for $6,000. And I would definitely say “Yes.” With just a few steps, you could have $6,000 to $12,000
invested in a tax sheltered account versus a taxable account. You’ve already paid taxes on it,
so why not shelter it with a few additional minutes of work. If you were to invest $6,000 in
a taxable account, as the account appreciates, you will have gains that you will need to eventually
pay taxes on. $6,000 may not seem like a lot now, but if you had that invested for 30 years at 8%,
it could grow to 10x that. $60,000. And you’ll need to pay taxes on all that gain of $54,000.
If you take a few minutes to invest that money into a Roth IRA account using the Backdoor
Roth IRA method. You are saving thousands of dollars you need to pay in taxes down the line.
Alright, now that you are convinced you should take the time to do a Backdoor Roth IRA,
let me walk you through the steps with Vanguard. There are 5 essential steps you need to follow
and I’ll walk you through them in detail. Feel free to pause at any time in the video. Step 1,
is to open a Traditional IRA account. You need a Traditional IRA account before you
can rollover the fund to a Roth IRA. In order to do this, first when you get to Vanguard’s website,
click Open an Account at the top of the page. From here you’ll select Start your new account.
I’ll assume you’re using your bank to make your initial investment. If you’re not already a
Vanguard client, select No, I’m new here. Here’s a look at the process and the things you’ll need to
get started. The process will take about 5 to 10 minutes. Once your money reaches your new account,
you can start investing. You’ll begin by selecting your goal and a related account type. Your account
will act as a container for the investments you’ll choose later—such as index funds, or ETFs. We’ll
select a Retirement (IRA) account for one person. Next, you’ll provide your personal information.
Review your details for accuracy. You’ll then create a username and password. In addition,
you’ll agree to web terms and paperless documents. You’ll also set up your security questions.
Next, you’ll add the bank account you’ll use for transactions. All new accounts require a
bank-on-file. Select your bank from a list of popular banks, or search for it manually by
name. After logging into your bank, select which checking or savings account you’d like to use.
Next, choose if you want to transfer money from your bank now or later. You don’t need to transfer
money yet, we’ll do that in step 2 when we make your non-deductible IRA contribution. In the next
step, you’ll enter your employment information. Certain occupations may have additional rules
and regulations. On the next few pages, you’ll answer some final questions which are required
for all new brokerage accounts. Your answers won’t affect what products you can invest in,
and you can update them at any time. Once you review your information and accept our agreements,
you’ll receive a confirmation. Step 2. Let’s make a Non-Deductible IRA Contribution
into the Traditional IRA account that you just opened. After logging in,
go to Balance & holdings under My Accounts. Find your Traditional IRA brokerage account, and click
the arrow to the right of “Buy and Sell,” and select “Contribute to IRA.” Vanguard asks if
it’s a rollover from another tax-deferred account. Select “No.” Towards the bottom, you’ll choose the
year for which you want this contribution to count. This is a 2022 backdoor Roth tutorial,
so put the $6,000 into the 2022 slot. Next, tell Vanguard where this money is coming from. Since
you’ve already set up your bank account earlier, it should be available under the drop down menu.
Next, you’ll be asked to review and submit your IRA contribution. Double check to make sure that
you are making the appropriate contribution to the desired tax year and the fund is coming
from an appropriate account. If it looks good, go ahead and click SUBMIT. You’ll get a confirmation
and a nice “Thank you” from your new friends at Vanguard. Step 3 is to Open a Roth IRA Account.
The steps are pretty identical to opening up a Traditional IRA so I won’t go through
all the steps again here. Review the steps for Traditional IRA and open a Roth IRA Account so
we can convert our money into it. Step 4 is to Convert your contribution to Roth IRA. Now one
trickey item I want to call out is that even if you have a Roth IRA account and you just made a
non-deductible contribution into your Traditional IRA Account, you can’t do step 4 right away.
It usually takes a few days for you to be able to convert your non-deductible IRA contribution
to your Roth IRA. You just need to check in every few days to see if you can make your withdrawal.
At worst, you might need to wait a whole week depending on when you made your contribution.
But once you are ready, click on “Convert to Roth IRA.” Next, select “Convert all of the account.”
Scroll down the page, and select the box to states you will not elect to withhold federal and state
income taxes. We are converting a non-deductible IRA contributions. Since we’ve already paid tax
once on this money, the conversion shouldn’t cost us anything. Continue on to the next screen.
On the next screen simply review and submit your Roth conversion. The confirmation screen is pretty
straightforward. Alright step 5. Invest in the Roth IRA. In the last step, you successfully
moved your money from Traditional IRA to a Roth IRA. However, it isn’t invested in anything yet.
It’s still sitting in a money market account and you don’t want to just keep it there. It’s like
a checking account with almost no interest rate. You want to invest your money to grow
and good options are Vanguard’s total market index fund like VTSAX or Vanguard's S&P 500 Index fund
like VFIAX. In order to do this, click on “Buy Vanguard funds.” under ““Buy and Sell.” From here,
you can type in the fund name or symbol. Choose your index fund on the left with the settlement
fund, the money market, being used to fund the purchase. “Review and submit.” And you are done.
Congratulations, you have just legally funded your Roth IRA regardless of your income using
the Backdoor Roth IRA method. Now let’s cover some common backdoor Roth IRA errors to avoid.
After going through the process, you might have noticed that it is a bit meticulous. And there’s
a reason for that. The Backdoor Roth IRA is trying to take advantage of specific tax law requirements
setup by the Internal Revenue Service. So it’s important that you follow the steps outlined
in this video if you want to avoid issues with the IRS. The first most common Backdoor Roth IRA error
to avoid is forgetting to invest the money in a Roth IRA. As you saw earlier, when you convert
the money from a traditional IRA to a Roth IRA, your money is sitting in a money market account.
I’ve heard horror stories of people who thought they were done and stopped right there. They
thought they were investing in Roth IRA, which is technically true, but their money wasn’t invested
in any appreciating asset. So that $6,000 is still $6,000 years from now instead of growing. Don’t
forget the step to take the money in the Roth IRA account and invest it in a good index fund like a
total market index fund or a S&P 500 index fund. Another common Backdoor Roth IRA error you want
to avoid is to trickle in your contribution. This will make your financial life very complicated.
People do this because they are trying to automate their contributions. This is perfect for funding
your 401K or your brokerage account, but when it comes to something sensitive like a Backdoor Roth
IRA, it can create more problems than solutions. When you trickle in your contribution, you have
10s or even 100 small transactions you need to go through all the steps that we just went over.
Save yourself time and the headache. I’m assuming if you make enough money to contribute to a Roth
IRA using a backdoor strategy, you make enough to make the contribution all in one lump sum.
And a third common mistake with backdoor Roth IRA is not filling out a 8606 Tax Form when
it comes to tax times. 8606 is an IRS form you need to fill out when you make a nondeductible
contribution to a traditional IRA. Since you do this as a first step to a Backdoor Roth IRA,
it's important you include this form in your taxes. If you do your own taxes make sure to
include it. And if you have a CPA, let him or her know you did a Backdoor Roth
IRA so they know to fill out this form. That’s it guys. I’m sure we could talk many more hours
about the Backdoor Roth IRA but this covers the gist of the process. I will also have some links
for more detailed resources in the description below. Written by individuals way smarter than
I. If you are a high-income earner, take advantage of this process and invest in a Roth IRA. If you
like to learn more about all the different types of tax advantaged retirement accounts,
check out this video here. Thank you guys for watching, and until next time. All the best.