little while ago on The Simple Dollar, Saundra Latham

A little while ago on The Simple Dollar, Saundra Latham wrote a nice summary of how a backdoor Roth IRA works. Since then, I’ve seen a number of follow-up questions regarding backdoor Roth IRAs, so I thought I’d write a complementary article explaining some of the things that people were asking questions about.

Mostly, these questions centered around why a person would want to do this. Hopefully, between these two articles, any basic questions you have about a backdoor Roth IRA can be answered; if you have plan specific questions, you should talk to your investment firm or to your 401(k) plan administrator at work.

Let’s start off with explaining a few key terms, just so no one’s lost right off the bat.Big Boss vote

Invest in Your Financial Future

Invest in Your Financial Future
It’s never too late to get started by opening a Roth IRA or traditional IRA with one of the companies mentioned above. Even if you don’t have thousands of dollars each year to invest, anything you can get into an IRA account will pay off down the road. The money has the ability to compound year after year and to grow into something very significant.

No investment is guaranteed to make you money over time. However, you’ll at least have the opportunity to let your money grow and to avoid paying taxes when you invest or when you withdraw the funds (depending on whether you choose a Roth IRA or traditional IRA).

What Is an Automated Investing Service?

What Is an Automated Investing Service?
Automated investing services (sometimes called “robo-advisors“) like Betterment and Wealthfront use modern portfolio theory to build you a diversified basket of low-fee ETFs, or exchange-traded funds that offer much lower fees than standard mutual funds. Then they automate many functions like portfolio rebalancing, goal setting, and tax-loss harvesting (for non-IRA accounts).

Avoiding a 20% Withholding Penalty on a Rollover

Avoiding a 20% Withholding Penalty on a Rollover
The best IRA companies will assist you with a seamless transfer from your old account to your new IRA. One thing to note is that, if the transfer is done with a check, you’ll get charged a 20% withholding penalty. Obviously, you’ll want to avoid this at all costs, so inform your new IRA provider that you want the funds to be transferred directly from your previous account to this one.

IRAs allow anyone younger than 70.5

Income restrictions: Traditional  years old to contribute regardless of income. In order to contribute to a Roth IRA, a single filer must make less than $137,000 and married couples must make less than $203,000 combined.

Age restrictions: You can keep your money in a Roth IRA as long as you want, but a traditional IRA forces you to start taking distributions at age 70.5. You also can’t make any contributions to a traditional IRA after that age, but you can continue contributing to a Roth IRA as long as you’d like. Keep in mind that beneficiaries of Roth IRAs will not owe taxes either.

A Roth IRA also requires that you have the account open for at least five years before qualifying for a distribution. For example, if you open an account at age 57, you’ll have to wait until you’re 62 to take the money out without penalty, versus taking it out at 59.5 years old.

Withdrawal exceptions: A Roth IRA offers a number of advantages over the traditional IRA when it comes to withdrawal flexibility. If you withdraw from your Roth IRA early, you’re only hit with a penalty tax on the investment gains, not the money you originally put into the account.