Backdoor Roth IRA: What it is, Benefits, Limits, and how to set it up

"Backdoor Roth IRA" is simply a term to describe a strategy used by high-income earners who can't contribute to a Roth IRA because their income is above certain limits. Rather than contribute directly to a Roth, you contribute to a traditional IRA, and then convert it to a Roth.

A Roth IRA is a popular retirement savings account to which you contribute after-tax dollars, and if you meet certain requirements, you can withdraw both the invested money (principal) and earnings accrued on the money tax-free in the future. You might be a good candidate if you think you'll be in a higher tax bracket when you retire. The benefit of a Roth IRA is that it offers tax-free growth.

Backdoor Roth IRA income limits

If your modified adjusted gross income (MAGI) is above certain income limits, then the amount you can contribute to a Roth IRA is phased out. The phaseout occurs between $138,000 and $153,000 for single filers and $218,000 and $228,000 for joint filers in 2023. The backdoor method allows those with higher incomes who can't contribute in the typical manner to still take advantage of a Roth IRA.

How to set up a backdoor Roth IRA

1. 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.

2. If your 401(k) plan allows, you may be able to do a mega backdoor Roth conversion. Some 401(k) plans permit automatic Roth conversions, which means you can make after-tax contributions and have them automatically convert to Roth within their accounts. Check with your plan to see if this option is available to you.

When should you not consider this strategy?

A backdoor Roth IRA doesn’t make sense for everyone. If you're able to make a Roth IRA contribution the standard way, then you don't need to use the backdoor method.

If you have a balance in a rollover IRA and plan to contribute to that account, you may not want to make a backdoor Roth conversion because of the "pro rata" rule. This rule requires all IRA distributions to be taken proportionally from your pre-tax and after-tax contribution sources. This could limit the tax benefits you'd receive from a Roth conversion. For example, if you have a total of $1 million in IRA assets, and $100,000—or 10%—is after-tax money, then 10% of any withdrawal must be taken from after-tax money. For a $10,000 withdrawal, $1,000 would have to be after-tax money.

It's important to keep in mind when you plan to use the money. If you're looking to withdraw the money within 5 years, you may not receive all the Roth tax benefits.* Also, when creating a backdoor Roth IRA, you'll have to work with an accountant to file tax forms to ensure you complete it accurately.

What are the benefits?

The main benefit of a backdoor Roth IRA contribution is the ability to contribute to a Roth IRA even if your income is too high to contribute directly.

Making a backdoor Roth contribution means that the money converted to the Roth IRA will not be subject to required minimum distributions (RMDs) after the account holder turns 73. Having money in a Roth IRA also provides tax diversification for the account holder once they reach retirement. If the five-year rule requirements are met and you are at least 59½, there are no 10% early withdrawal penalties and withdrawals will be tax-free.

With the enactment of the Secure Act that went into effect on January 1, 2020, the rules for inherited IRAs for most non-spousal beneficiaries changed. Prior to this, those inheriting an IRA could stretch it out over their own lifetimes in most cases. While RMDs are required for IRAs inherited prior to these new rules, the ability to stretch the RMD payments out over a longer period has served to minimize the tax hit for many beneficiaries.

The Secure Act changed the rules for what are called “non-eligible designated beneficiaries.” This includes many non-spousal beneficiaries. The new rules require that these beneficiaries must withdraw all of the money within ten years from an IRA inherited beginning in 2020 or later (the 10-year rule).

In the case of an inherited Roth IRA, the 10-year rule still applies. However, the withdrawals will be tax-free as long as the original account holder satisfied the five-year rule on the account prior to their death. This can allow the beneficiaries to keep more of their inheritance.

Who is the backdoor Roth for?

The backdoor Roth technique is mainly for those investors who want to be able to contribute to a Roth IRA, but who earn too much in a given tax year to do so. To benefit from a backdoor Roth IRA, you need to be able to pay any extra taxes that might be triggered by the conversion. This is true of any type of Roth conversion, or for any type of taxable withdrawal from a traditional IRA. If you don’t have the cash on hand to pay taxes on the conversion, it may not be a good strategy.

How to do a backdoor Roth conversion

  • Contribute to a traditional IRA. Contributions are typically made on an after-tax basis, though you could make a pre-tax contribution if desired.
  • Convert your contribution to a Roth IRA. If you already have a Roth IRA account open that’s great. If you don’t you will need to open a Roth IRA in order to complete the process.
  • Pay any applicable taxes as part of your tax return for the year in which the backdoor Roth IRA is done.

What are the tax implications?

Typically the contributions to start the backdoor Roth IRA process are made on an after-tax basis to a traditional IRA account.

There may or may not be any taxes when the conversion from the traditional IRA to a Roth IRA are made. This will be governed by the pro-rata rule. This rule says that if you have amounts in a traditional IRA that consists of money contributed on a pre-tax basis, the amount converted is taxed based on the ratio of after-tax contributions to pre-tax contributions and earnings in total across all traditional IRA accounts you may hold. Note that beyond just regular traditional IRA accounts, the calculation would also include amounts in a SEP-IRA or SIMPLE IRA account.

If you do not have any other money in a traditional IRA, your backdoor Roth IRA might be tax free. If you contribute $6,500 after-tax to a traditional IRA and do the conversion right away, the conversion will be tax-free assuming that your contribution to the traditional IRA did not have any earnings in between the time of your contribution and the time when the conversion occurred.

Using the same $6,500 after-tax contribution, if you wait for a period of time and there are earnings inside of the traditional IRA, then the conversion will be taxed based on the ratio of the amount pertaining to the tax-free contributions and the earnings portion of the conversion.

Let’s say that the earnings in the account are $250 by the time you do the conversion. The total amount of the conversion was $6,750. The amount subject to taxes would be 3.7% of the amount converted. This is calculated as $250 divided by $6,750.

Let’s look at a different situation using the same $6,500 after-tax contribution to the traditional IRA. In the case of our hypothetical person, she has $100,000 in total inside of traditional IRA accounts counting the $6,500 contribution. Of this $100,000, $20,000 is the result of after-tax contributions and the rest consists of money contributed on a pre-tax basis plus earnings inside of the accounts. Of any money she converts 80% will be subject to taxes.

Backdoor Roth IRA contribution limits for 2023

The IRA contribution limits for a particular year govern the amount that can be contributed to a traditional IRA to start the backdoor Roth process. The IRA contribution limits for 2023 are $6,500, with an additional $1,000 catch-up contribution for those who are 50 or over.

The other limit that pertains to backdoor Roth IRAs are the income limitations on the ability to contribute directly to a Roth IRA account. This is the main reason that people do a backdoor Roth IRA. For 2023, these following are the income limits on the ability to contribute directly to a Roth IRA.


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