A Roth IRA is an Individual Retirement Account to which you contribute after-tax dollars. While there are no current-year tax benefits, your contributions and earnings can grow tax-free, and you can withdraw them tax-free and penalty-free after age 59½ and once the account has been open for five years.
Every time you get paid, I recommend having a transfer from your checking account to your Roth IRA account. Set it up to be an automatic transfer so that you don’t have to think about it and can take advantage of dollar cost averaging. This simple and convenient method ensures that you are consistently contributing to your Roth IRA, without any additional effort on your part. You can easily set up a Roth IRA at Fidelity or Vanguard. My favorite is Fidelity because I find it the easiest to use. Once you’re set-up invest in low cost S&P 500 index funds.
What happens if your income exceeds the limit but you want to contribute to a Roth IRA? Well, you are in luck because you can take advantage of a “backdoor Roth IRA” that allows high-income earners to still contribute. It’s a (legal) loophole where you contribute after-tax money into a traditional IRA and then convert it to a Roth IRA. And just like that, you have money in a Roth IRA. This strategy is not only legal but also a reliable method for high-income earners to contribute to a Roth IRA.
The conversion would be part of a 2-step process, often called a “backdoor” strategy.
Contribute money to an IRA, and then roll over the money to a Roth IRA. For this strategy to work, you should contribute to a traditional IRA with no balance. If there’s a balance in the IRA, there could be a taxable event when you convert. Once you contribute to the account and wait for any required holding period, you’ll then convert the account to a Roth IRA. Any money earned due to market performance before the conversion takes place is subject to taxes. The contribution is considered nondeductible once you fill out IRS Form 8606 and complete your tax return. Note that there’s no tax benefit for the year you establish a backdoor Roth IRA.
However, make sure you understand the tax consequences before using this strategy. I recommend speaking with your tax professional before making any moves.
I hope this was helpful!
