One of the good things that has happened to Cat and I over the years is we have almost always had good income; with the exception of the disaster. The downside, if you can call it a downside is that we do not qualify for certain financial tools because of our higher income. The Roth IRA is one of those things. However, we can still use the Roth IRA as an investment tool, even though we don’t qualify for pre-tax Roth contributions. This is achieved by performing a Roth IRA rollover from a traditional IRA.
Why do I want a Roth IRA? Because the growth and withdrawal of money from a Roth is tax free. Tax free growth is better than taxed growth and tax free withdrawals are good for controlling our taxable income when we reach FI and stop working.
Because of our income, any money we want to save next must come from post-tax money. If this is placed into a savings or brokerage account, we pay tax as the money goes in, as it grows and when we withdraw it*. The information below compares the growth rates of a simple savings account and a Roth account.
You can see in this hypothetical example, the Roth growth far outstrips the savings account.
But if we use the Roth conversion, we can get tax free growth and tax free withdrawal of our money. The caveat is that the amount you can backdoor into the Roth is capped. At the time of writing, this is $7000 including top up amount. This is for each person so Cat can also put $7k into a Roth IRA each year. Here is how you do it.
- Move $7000 of your post tax money into a traditional IRA
- Transfer the $7000 from the traditional IRA to the Roth IRA
- Make sure your paperwork is correct when you do your taxes
- Only do this once per calendar year!
I am assuming here that you have both IRAs with the same brokerage company. It is generally best to do this otherwise this gets complicated.
There is a lot of detail packed into these three steps and I’m not going to tell you how to go into this but, White Coat Investor has a great tutorial about Roth conversions
While this on its own is not going to make you rich, this step only takes a few minutes each year and can make a difference in your savings vs a traditional savings account, and in retirement can help limit the amount of money you lose to taxation.
*potentially depending on how we handle the withdrawal of the monies.