5. Roth IRA

A Roth IRA is a retirement account where you contribute after-tax dollars, and your investments grow tax-free. Withdrawals in retirement are also tax-free, provided certain conditions are met.

Why Use Roth IRA?

• Tax-Free Growth: Earnings and withdrawals are tax-free in retirement.
• No Required Minimum Distributions (RMDs): Unlike traditional IRAs, you aren’t forced to withdraw funds at a certain age.
• Flexibility: You can withdraw contributions (but not earnings) penalty-free at any time.
• Ideal for Future Tax Savings: Beneficial if you expect to be in a higher tax bracket in retirement.

Example

Assume:

• You contribute $6,000 annually ($500 monthly) to a Roth IRA for 30 years.
• Your investments grow at an average annual return of 7%.

After 30 years, your account balance would be approximately $658,000. All withdrawals, including earnings, are tax-free in retirement.

Backdoor ROTH

A Backdoor Roth IRA is a strategy for high earners to contribute to a Roth IRA, even if their income exceeds the Roth IRA limits. This strategy bypasses Roth IRA income limits ($153,000 single / $228,000 married in 2023).

Steps to Set Up a Backdoor Roth IRA

1. Contribute to a Traditional IRA: Make a non-deductible contribution to a Traditional IRA (up to $6,500 in 2023, or $7,500 if you’re 50+).
2. Convert to a Roth IRA: Convert the Traditional IRA funds to a Roth IRA. This step is tax-free if you have no other pre-tax IRA balances.
3. Pay Taxes (if applicable): If you have pre-tax IRA funds, the conversion will be partially taxable based on the pro-rata rule.