Tax Deadline Checklist: Roth IRA Contributions

Written by: Derek Melvin

As we approach everyone’s favorite season, tax season, there will be many items to gather and complete ahead of the tax filing deadline of 4/15/2024 for 2023. One item that sometimes gets forgotten when putting together your tax filing checklist is Roth IRA contributions.

If you have some money sitting around that you would like to make good use of for your future self, Roth IRA contributions can be extremely useful. Remember, with Roth IRA funds, the dollars grow tax-free, and you do not pay taxes on these monies in retirement. These accounts are usually the most common resource of tax-free income in retirement.

For Roth IRA contributions, you have until the tax filing deadline (April 15^th for 2024) to contribute for prior year contributions. With that said, you still have time to make contributions for 2023 if you have not already.

See below for a breakdown of how to complete prior year Roth IRA contributions.

2023 Roth IRA Contribution Limits

For 2023, you can contribute up to $6,500 or 100% of earned income ($7,500 if over age 50), whichever is less, to a Roth IRA. This limit increased to $7,000 per person in 2024.

If you plan on making 2023 contributions ahead of the tax filing deadline, you are able to do so at any time.

Before Proceeding, Make Sure of the Following:

If you are making direct contributions to a Roth IRA, make sure you are below the income limits set for Roth IRA contributions. Click here to see the specific breakdown for 2023 Roth IRA income limits for each tax filing status.
- If you earned under $138,000 as a single individual, you are allowed to contribute the full $6,500 to a Roth IRA ($7,500 if age 50 or over).  If you earn between $138,000 and $153,000, you can contribute a pro-rated amount.
- If you earned under $218,000 as a couple filing jointly, you are allowed to contribute the full $6,500 to a Roth IRA ($7,500 if age 50 or over).  If you earn between $218,000 and $228,000, you can contribute a pro-rated amount.
- If you are married filing separately, the income limit is only $10,000.
Once you make your contributions, be sure to label the contributions as prior-year contributions if you plan on having contributions be for 2023.

Backdoor Roth IRA

Naturally, the next question that comes up is what do you do if you are over the income limit? Despite being over the income limit, you can still make Backdoor Roth IRA contributions. The Backdoor Roth IRA, or formally known as the Non-Deductible IRA contribution method, allows you to make fully legal Roth IRA contributions despite being over the income limit.

Before completing Backdoor Roth IRA contributions, it may be best to reach out to a financial advisor or tax professional before proceeding as there are certain rules, such as the Pro-Rata rule, that may make you ineligible to contribute. If you would like to speak to one of our financial advisors about making Backdoor Roth IRA contributions, reach out to us and we would be glad to discuss this with you further.

How To Complete the Backdoor Roth IRA

The backdoor Roth IRA is really quite simple, but easy to mess up, so follow closely.

1. Make Sure You Have a Clean Work Surface

Pretend like you are baking a cake and following a recipe.  The first step is to have a clean work surface, so no debris inadvertently gets in your batter.

What I mean by having a clear work area is that you cannot have any other IRA accounts with a balance in them.  If you have an existing Traditional IRA, SIMPLE IRA, or SEP-IRA, stop immediately.  Do not pass go.  Do not collect $200.

If you reach this point, as mentioned, it may be best to speak with a financial advisor on the ways you can move existing Pre-Tax accounts (Traditional IRA, SIMPLE IRA, or SEP-IRA) to make you eligible for the Backdoor Roth IRA.

2. Open A Traditional IRA and Contribute Money Into It

If you are set to proceed from Step 1, here is how the Backdoor Roth IRA works.

It is easiest if you contribute the full amount all at once, rather than spread out over time.

For 2023 contributions, the contribution limit is $6,500 per person ($7,500 if over age 50). For 2024, this amount increased to $7,000 per person ($8,000 if over age 50).

IRA stands for Individual Retirement Account, so only one individual can own the account. Therefore, if married, each spouse will need to open their own account.  If only one spouse earns income, the income-earning spouse can contribute to the non-income earning spouse’s account.

3. After Funding the Traditional IRA, Convert the Balance of the Traditional IRA Into Your Roth IRA

This can usually be done online, or by signing a form, depending on the company your accounts are held at.  If you don’t already have a Roth IRA, open one up and then convert the Traditional IRA into it.

You should convert from the Traditional IRA into the Roth IRA as soon as possible.  Usually, you will have to wait a few business days for the money to settle in the account before it can be converted (the investment company needs to make sure the bank clears the deposit before moving the money elsewhere).

If you invest the money in the Traditional IRA before converting it into the Roth IRA, you will be required to pay income taxes on any investment gains, hence why it is best to convert it into the Roth IRA as soon as possible.

4. Once the Money Is In the Roth IRA, Get The Money Invested

The last thing you want to do is leave your new contribution in cash, as it will have no chance of growing over time.

If you would like to learn more about how to invest your Roth IRA, this a where talking with a financial professional can come in. It is extremely important to invest according to your financial goals and investment time-horizon.

5. (Most Imporantant) File Your Taxes Correctly

When you file your taxes, be sure to let your accountant know you made a NON-DEDUCTIBLE IRA contribution and then subsequently converted the non-deductible IRA into a Roth IRA.  Non-deductible means you are NOT taking a tax deduction on the contribution.  It is money you already paid income taxes on.  This way, you don’t have to pay any taxes on that same amount when it is converted into the Roth IRA.

It’s also important to correctly report the year for which the contribution is going in.  If you are making a prior year contribution for 2023 before the tax deadline (even though it is 2024 now), you must report the contribution as a 2023 contribution with the investment company and on your tax return.

If you have done your own taxes up to this point, I recommend working with an accountant instead of moving forward.  If you are insistent on continuing to do your own taxes, make sure you document this correctly when filing taxes.  Good luck to you.

The IRA Form 8606 for Non-Deductible IRA’s

An IRS form 8606 will be generated and filed with your tax return to inform the IRS that you did not take a tax deduction on your contribution to the Traditional IRA.  If that form isn’t on file with your tax return, the IRS assumes the money in your Traditional IRA is pre-tax money that you didn’t pay taxes on yet (because normally that is the case with Traditional IRA’s).

Again, super important that you report your IRA contribution as a non-deductible IRA contribution, and the IRS form 8606 that documents non-deductible IRA’s is filed with your tax return for that year.

When you convert your Traditional IRA into your Roth IRA, the investment company your account is held at will populate a 1099-R statement for the year the conversion occurred in.   The 1099-R statement shows that money came out of a retirement account – in this case, a Traditional IRA.   Normally, you have to pay income taxes on all money being converted from a pre-tax retirement account into a Roth IRA.

If the non-deductible contribution was not documented correctly and the Form 8606 is not filed, the IRS assumes you converted pre-tax money into a Roth IRA, which is a taxable event.

This will cause one of two things to happen. The tax software will assume it was pre-tax money that was converted into the Roth IRA, and you will end up erroneously paying income taxes on the amount converted, even though you already paid taxes on that money.  So, you end up paying double taxes.  Be sure to double-check your tax return before filing.   If the form 8606 isn’t in there, it wasn’t done correctly.

Or, if you forgot to report the contribution altogether, you won’t pay income taxes on the money being converted, because you know you already paid income taxes on that money.   However, the IRS will get wind of this conversion when the 1099-R is generated and will incorrectly assume that you should have paid taxes on that money being converted.  In this case, the IRS will be very, very angry with you. About a year later (because the government is slow), you will get an angry letter from the IRS informing you of how angry they are.   They will also demand you pay income taxes, plus a penalty, on that money that was converted into your Roth IRA.

Not fun to be on the wrong side of the IRS.  If this does happen, you can remedy the situation by writing a letter explaining what happened and amending your tax return to properly document the non-deductible contribution with the form 8606.  This can be a pain in the tuchus, and it will cost you money to amend your tax return, so try to document everything correctly the first time around.

Backdoor Roth IRA Summary

Roth IRA’s are great because you can withdraw from them tax-free in retirement. The Backdoor Roth IRA is a unique strategy that enables high-income earners to potentially add new money to a Roth IRA each year.

There are some important rules to follow if you are going to pursue the Backdoor Roth IRA strategy. They are straightforward, yet easy to miss if you’re not attentive.

Remember:

Step 1 – clear your work surface. Make sure no money is in a Traditional/SEP/SIMPLE IRA with your name on it.

Step 2 – add money to a Traditional IRA.

Step 3 – convert Traditional IRA into Roth IRA.

Step 4 – invest the money in the Roth IRA.

Step 5 – report that you made a nondeductible IRA contribution and ensure that an IRS form 8606 is filed with your tax return.

If you want more hands on assistance in completing the Backdoor Roth IRA or simply learn more about why this may be important for you, talk to one of our financial advisors to gain some more information.

Conclusion

As mentioned up top, Roth IRA’s can provide a strong source of tax-free retirement income and is a great addition to your overall investment portfolio. If you would like to make contributions for 2023, still plenty of time to get those completed.

If you have any questions on Roth IRA contributions, retirement planning, or investment strategies, feel free to reach out to us and we would be glad to get an initial meeting scheduled.

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