Modeling a Backdoor Roth IRA in eMoney

Many high-income earners believe that the tax-deferred earnings and tax-free withdrawal benefits of a Roth IRA are closed to them. After all, in order to open a Roth IRA, a single person cannot earn more than $133,000 a year in Adjusted Gross Income.

Luckily, due to a rule change made by the IRS in 2010, there are no limits placed on income when converting a Traditional IRA. Since then, savvy financial planners have helped their clients increase their tax-free funds available during their retirement with a “Backdoor” Roth IRA.

What is a Backdoor Roth IRA?

Simply put, a Backdoor Roth IRA refers to a method of avoiding income limits of opening a Roth IRA. But, don’t worry, the “Backdoor” name doesn’t mean this method isn’t IRS approved.

The basic steps to performing a Backdoor Roth IRA are simple. Although actual execution of these steps can be more complex.

  1. Start by opening and contributing to a Traditional IRA.
  2. Then convert your Traditional IRA into a Roth IRA with a rollover, trustee-to-trustee or same trustee transfer.
  3. Pay any resulting taxation on untaxed amounts in the Traditional IRA.  (See IRS Publication 590-A and Form 8606 for more information.)
  4. Enjoy your new Roth IRA account.

Typically the taxes generated from this method of conversion will be minimal, as the transfer flows are moving after-tax dollars between the accounts.  Taxes owed would be primarily due to any investment earnings from the date of the initial contribution through the date of the conversion.

Note: If transferring deductible traditional IRA contributions from an existing account there is a larger potential tax hit as any deductible contributions and their investment gains will be taxed in the year of the conversion. 

How can I model a Backdoor Roth IRA in eMoney? 

For this example, we’ll start by creating an Advanced Planning Scenario on the client’s Plans tab.

Then using the Add a New planning technique, create the Traditional and Roth IRA accounts –being sure to designate that they are available in the current year.

Once the accounts have been created, we’ll create a Transfer flow designed to fund the initial contribution to the Traditional IRA. For the Transfer Flow, we’ll need to set the Annual Amount, Source account, and Destination account according to our client’s unique circumstances. Then, set the Starts and Ends drop-down menus to the current Calendar Year, before finally ensuring the toggle Contribution Deductible? for Traditional IRA’s is set to No.

Now that we’ve created and funded our Traditional IRA and created our Roth IRA, we can model the backdoor conversion by adding a second Transfer Flow to our scenario.

This Transfer Flow should transfer all monies from the newly funded Traditional IRA to your Backdoor Roth IRA account and also Start and End in the current Calendar Year.

Pro Tip: Transfer Flows execute in alphabetical order, so be sure to name your backdoor conversion to execute after your initial contribution to the Traditional IRA.

You can look at the ledger to check this transaction is working appropriately. If there is no current money in an IRA, you will not see any taxes and it will flow smoothly into the IRA and right back out to the Roth IRA.

And now that you’ve created the Roth IRA, you can continue to model additional backdoor Roth contributions for the client by creating a transfer flow to the Traditional IRA and then another transfer flow of the same amount to the Roth IRA in the same year. So this backdoor technique can continue to benefit high-earners for years to come.

Joseph Pearson

Written By

Joseph Pearson is a Client Communications Strategist with eMoney Advisor, LLC. A three-time eMoney Wingbowl Champion, one-time Chili Cook-off Runner-up and Gold Stevie® Award-winning Front-Line Customer Service Professional of the year for 2016 - Joe is a proud father, devoted husband, and he always tries turning it off and back on again before calling IT.