Backdoor Roth Conversions Under Fire? How You Can Protect Your Investment Strategy

“Backdoor” Roth IRA conversions have been a staple strategy for high earners since 2010. However, recent legislative attempts have been made to eliminate this tax loophole and, with it, the retirement benefits this option provides. 

Though the backdoor Roth conversion has survived for now, the future of this portfolio strategy remains uncertain. It’s apparent that legislators have their sights fixed on getting rid of this retirement savings method. 

Before it’s too late, it’s worth asking yourself what actions you can take to maximize your nest egg while backdoor Roth conversions are still an option.

What Is the Backdoor Roth Conversion and Why Is It Important?

IRAs are a popular type of retirement savings account because they allow individual investors to save money outside of company retirement plans such as a 401(k). The most common IRAs are the traditional and Roth IRA accounts. The biggest difference between these two is the timing of your tax benefits. 

With a traditional IRA, money is contributed pre-tax and provides the benefit of lowering taxable income through qualifying deductions. When it comes time to withdraw from the account in retirement, withdrawals are counted as ordinary income and are taxed according to your current income level.

Roth IRAs allow individuals to put in after-tax contributions. These contributions are not tax-deductible, but they will grow tax-free and withdrawals can be made tax-free after age 59½. The ability to contribute money that will grow tax-free and make tax-free withdrawals in retirement is of enormous appeal to those who expect to be in a higher tax bracket later in life. Paying lower taxes now instead of higher taxes later can yield major savings for those savvy enough to take advantage.

The catch to a Roth IRA is that only those with income levels under a specified limit may contribute to them (2022 income limits are $144,000 for single filers and $214,000 for those married filing jointly). This means high-income individuals cannot directly take advantage of the tax benefits of a Roth IRA. 

Here’s where the “backdoor” comes in. Because Roth IRAs can provide such immense tax benefits, high-income earners still want to be able to leverage them. To get around the income limits of the Roth IRA, individuals can open a traditional IRA and then convert it to a Roth down the road. Though perhaps a bit indirect, this Roth IRA conversion is completely legitimate according to current law.

Current Threat to the Backdoor Roth IRA

In November of 2021, the House of Representatives approved a draft of the Build Back Better bill which would have eliminated the ability of investors to backdoor into a Roth IRA. 

The bill did not ultimately pass in the Senate, but it’s clear that the politicians of our day are looking for a way to eliminate this option for wealthier investors. While the backdoor Roth is currently legal, it may not stay that way much longer.

Knowing that backdoor Roth conversions may be on the chopping block in the near term, it’s worth planning ahead and looking for investments that will help keep your portfolio diversified and your retirement goals on target. You can continue to use the backdoor traditional-to-Roth IRA conversion strategy for now, but what will you do if this option disappears?

What to Do If Backdoor Roth Conversions Are Banned

Should the day come when the backdoor Roth conversion is finally eliminated, you need to have a savings plan which will allow you to continue growing toward your financial objectives without these tax advantages. 

You more than likely have traditional 401(k) (or similar retirement account) and IRA accounts already. These types of accounts are necessary investment tools, but these investment vehicles only allow you to buy certain types of assets (e.g., mutual funds, stocks, bonds, ETFs). 

Having additional options is important and can help you increase your level of diversification and, more importantly, your portfolio growth and income potential.

Self-directed IRAs (SD-IRAs) are a great choice for investors because they allow you to choose from a much wider range of investment assets. SD-IRAs open the playing field to assets like residential and commercial real estate, precious metals, cryptocurrency, venture capital opportunities, peer-to-peer lending, private equity, and hedge funds.

SD-IRAs are different from regular IRAs in that they are truly self-directed. Investors must research potential assets and fully evaluate them as investment opportunities on their own. In contrast to standard IRAs and 401(k)s, there isn’t a database of assets from which to select investments. If you have existing familiarity with a particular class of assets, an SD-IRA is likely a logical step for you to take.

Making sure to leverage as many savings tools as possible will help you pursue a more comfortable retirement, regardless of which way the political winds are blowing at a given moment. Investing is an ever-changing landscape. Knowing how to traverse it wisely can be the difference between riches and rags. 

How to Grow Your Savings in Spite of Change With Chicago Trust Administration Services

Investors should still continue to save and invest no matter the outcome of the backdoor Roth conversion. Your financial success should never be determined by stifling legislation, but you can take note of what’s going on in Washington and start thinking about contingent strategies. 

Investing some of your retirement savings in alternative growth and income-producing assets can be a good way to increase return potential, insulate against market volatility, and create streams of passive income in retirement.

At Chicago Trust Administration Services, we assist investors looking to take control of their futures by investing in self-directed IRAs. We are SD-IRA custodians who provide IRS-compliant services to help you make transactions that will reliably grow your portfolio. Partnering with us will provide you with an advocate who works alongside you to successfully navigate the many different investment options available at any given point in time.

The wider investment opportunities available through SD-IRAs afford investors multiple sources from which to build wealth. The investment diversity you can achieve through these types of accounts will help you build a nest egg worthy of your retirement goals. This is especially true when you consider that traditional methods of investing may only become more difficult for high-income earners to take advantage of as time goes on.

To better understand how we can help you grow your retirement savings, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com. 

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*The content and opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

**CTAS professionals are not financial advisors and cannot provide advice or recommendations regarding specific investment decisions.