What are the alternatives to backdoors Roth IRAs? This is a question that I have been getting quite frequently from those around me, so I decided to do some research and find out what alternatives there are to this type of IRA conversion. Fortunately, I found some options that I think will be valuable for you, and anyone else who is trying to establish the way forward. Read on to find out what you are required to do.
For many years, the U.S tax code has made a provision for people in the high-income bracket to get past the income restrictions that are placed on the tax-advantaged IRAs. With a backdoor IRA or a Roth conversion, you can move your money into investments that grow tax-free.
It is, however, looking like this opportunity may be off-the-table soon. This year (2022), it is expected that the proposal forwarded as part of the Democratic domestic policy bill in 2021, will terminate the existence of backdoor Roth IRAs.
This stems from the realization that many wealthy people, including the high-profile ones, have used the backdoor Roth provision to build massive wealth. In a ProPublica report released in June, we saw how Peter Thiel, a renowned tech magnate, managed to convert an investment of $2000 into $5billion. This investment could become tax-free, thanks to the Roth IRA provision.
Congress does not seem very impressed about such loopholes that enable people to build a lot of wealth tax-free, and this could mean that the chance to use a backdoor Roth IRA could be soon unavailable to those in the high-income bracket.
If backdoor Roth IRAs are eliminated, or stricter limits imposed on them, then it will be a good idea for investors to consider other alternatives, which we shall discuss in a moment.
What are backdoor Roth IRAs?
High-income earners do not have as many retirement savings options that come with great tax benefits, save for backdoor Roth IRAs, owing to the manner in which they make it possible for them to access and invest their savings just like the middle-class population.
Roth IRAs are different from traditional IRAs, in that the contributions made to Roth IRAs are in after-tax dollars. Only those who have an income of $140,000 or less are allowed to make non-backdoor Roth IRA contributions, in the case of single taxpayers.
About 10 years ago, however, a change was effected, and it made it possible for people who put their money into traditional IRAs to convert them into Roths, without being restricted by the set income limits. Without the opportunity to make such Roth conversions, then those in the higher income tax bracket (based on their income), will have fewer options available to them.
What are the alternatives to a backdoor Roth?
If Congress proceeds to make the backdoor Roth IRAs out of reach, there are options that you could utilize, as much as they might not be as effective as the Roth conversions.
1. Health Savings Account
For those who have high-deductible healthcare plans, then opening health savings accounts (HSAs) is a good way to save some tax-free money to meet their medical expenses that are not covered by their insurance. You will be surprised to learn that these accounts happen to be some of the most tax-advantaged options, according to the experts.
The average American is unfortunately not maxing out the benefits of HSAs as they should be, but they could soon turn to them if the backdoor Roth IRAs are eliminated.
Benefits of Health Savings Accounts
- Unlike Roths, those with HSAs can make before-tax contributions to their accounts. Also, the money contributed to the HAS can grow tax-free, and be withdrawn tax-free. This is, however, limited to the qualified cases that are related to the account owner’s care.
- Allows for employers to match the contributions made by the account owner.
- As much as there is an additional 20% tax penalty for the withdrawal of funds for other purposes besides healthcare, this penalty is waived for those who become disabled or are aged over 65.
Drawbacks of HSAs
- The maximum amount that employees and their employers can jointly contribute to their health savings account is $3600, for individual contributions, and $7200 for family contributions.
- The account holders are required to have high-deductible health plans, which are not offered by many employers, and may not be the best option for everyone.
2. Cash-value life insurance
Your permanent life insurance policy comes with a savings component to it, that can be of value to you while you’re still alive. Some of its savings benefits are to a great extent similar to those offered by Roth IRAs. The only reason behind why people turn to Roth IRAs, and not Cash-value insurance is that life insurance policies happen to be quite complex.
Benefits of Cash-value life insurance
- The funds in your permanent life insurance plan can grow tax-deferred.
- You can take a loan against the value of your permanent life insurance policy, without the proceeds of your loan not getting taxed.
Drawbacks of Cash-value life insurance
- These plans are not built to serve as retirement savings vehicles and owing to the complexity of their structures, they can end up being quite costly.
- Policyholders who take out loans against such policies are required to repay them if they expect to still maintain the underlying death benefits. It is therefore wise to consult with your insurer about the sustainability of your cash-value life insurance policy before using it as an alternative to a backdoor Roth IRA.
Other possible alternatives to backdoor Roth IRAs
If the above-listed options are not suitable for you, then you can consider the following ones:
- Cash-balance retirement plans are used in conjunction with a 401(k)- doing this enables one to contribute more money than they would be by contributing to a traditional IRA.
- Check whether you are maxing out your contribution limits under the retirement savings plan offered by your current employer.
- Traditional IRAs are still a good alternative to those who are trying to grow their money over the long-term horizon
These strategies are, however, subject to capital gains and other types of taxes.
Investors can also consider opening self-directed IRAs, to invest in assets that have a high-income generation potential, and greater diversification benefits. Check out the review of our top-recommended gold& silver IRAs, for instance, to which IRAs are good for those who want to diversify their portfolios in the best manner possible.
That will be all for this article on what the alternatives to backdoor Roth IRAs are. I hope you found the article educational, and that you will pick the most suitable alternative, based on your financial goals and expectations. Let me know if you have any questions with regards to today’s topic, and whether you need any help finding the best gold & silver IRA- drop your questions in the comments section, and I will get back to you ASAP.
I wish you well,
Eric, Investor and Team Member at Gold Retired!