Backdoor Roth IRAs

Backdoor Roth IRA: What It Is and How To Do It

Roth IRAs are amazing retirement savings vehicles because contributions grow tax-free and qualified distributions are entirely tax-free. Saving in a Roth IRA can maximize your income in retirement and help minimize taxes. However, not everyone can contribute to a Roth IRA. The income limit to make full Roth IRA contributions is $146,000 for single taxpayers and $230,000 for those married filing jointly in 2024. If your income is over those limits, you are only able to make a partial contribution or none at all if your income exceeds the upper limits below. High income earners may still be able to build Roth IRA assets by using what is called a backdoor Roth.

What is a backdoor Roth IRA?

A backdoor Roth IRA is a strategy used by high income earners to build Roth IRA assets even when they exceed the income limit. While direct contributions are not allowed with higher incomes, conversions are allowed at any income. This allows high income earners to contribute to an eligible vehicle, a non-deductible IRA, and then convert those dollars to a Roth IRA. While anyone can do a backdoor Roth IRA regardless of income, it is easier and simpler for those under the income limit to just contribute directly. If you are unsure whether you will exceed the income limit in a given year, it may be better to do a backdoor Roth conversion to be on the safe side.

Pre-tax IRA assets complicate backdoor Roth conversions and in some situations may make it infeasible or impossible to do a backdoor Roth conversion. These pre-tax IRA assets may be subject to what is called the Pro-Rata rule, which means they would be subject to tax if you do a backdoor Roth conversion. To avoid taxation on pre-tax IRA assets, one could consider converting pre-tax IRAs to a Roth IRA or rolling assets into a 401(k) or similar employer plan if it makes sense to do so.

How to do a backdoor Roth conversion

The process of a backdoor Roth IRA conversion can be simple, but mistakes may have big consequences, so it is always best to consult a tax professional or investment advisor if you have any questions about the process. If you know you can make a backdoor Roth conversion, you simply make a non-deductible IRA contribution and then convert those dollars to a Roth IRA. Any investment earnings in the non-deductible IRA are taxable, so generally conversions may be done quickly and before assets are invested. Some IRA custodians charge account closing fees, so it may make sense to leave a very small balance in the traditional IRA used for the conversion.

Tax Form 8606, Nondeductible IRAs, must be completed with your federal tax return in any year you use this strategy. Improperly filling out this form is all too common, which can lead to an overpayment of taxes by incorrectly reporting the conversion as income.

What is the income limit for a backdoor Roth?

There is no income limit to make a backdoor Roth conversion, but those with pre-tax assets may not be able to make this strategy work for them. The backdoor Roth is a great way for high-income individuals and families to build tax-free retirement assets.

Is backdoor Roth still allowed in 2024?

Federal legislation introduced in 2021 would have eliminated the backdoor Roth, but the final version of the act that passed was changed significantly (and renamed) and did not get rid of the backdoor Roth. The backdoor Roth is still alive and well in 2024, but it’s always possible that future legislation may effectively eliminate the backdoor Roth.

What is the downside to a backdoor Roth?

When done right, there are few, if any, downsides of doing a backdoor Roth. It allows high-income earners to build tax-free assets for retirement. However, if you have pre-tax IRA assets there could be big tax consequences for using the backdoor Roth strategy. It’s important to know exactly how any pre-tax IRA assets will impact your ability to do a backdoor Roth and to properly file Form 8606 with your federal return each year you use this strategy.

Is a backdoor Roth worth it if you have a high income?

Contributions made to a backdoor Roth are taxed, but grow tax-free and qualified distributions are entirely tax-free. Those with high incomes now could be paying more taxes on the initial contribution than tax benefits they receive in retirement if their income tax rate will be lower. However, there are benefits to building tax-free retirement assets even for those with higher incomes. If your income is high now and you are saving a significant amount for retirement, chances are you will wish you had as much in tax-free accounts as possible in retirement. It adds a layer of tax diversity if you are also contributing to a pre-tax employer-sponsored plan and taxable brokerage account. Even if you are taxed at a high rate now, your future retired self will thank you for building tax-free assets for retirement.

What if I move to another country?

Roth IRAs are usually not able to be rolled over to international retirement or investment accounts without penalty or taxes. However, you may not need to move your Roth IRA if you move to a different country. It’s possible to still be able to contribute to your Roth IRA if you earn income taxable by the US. The same rules and stipulations apply to withdrawing from your Roth IRA while overseas, but an additional complication can be converting or transferring currency from US dollars to your local currency. Not all countries treat Roth IRAs the same, and some countries tax Roth IRA gains, or income and dividends, annually. Some countries even fully tax Roth IRA distributions in retirement. Before deciding what to do with your Roth IRA when moving to another country, you need to know exactly how that country will treat it and tax it.

Backdoor Roth IRAs are a great way for high income earners to build tax-free retirement assets. While there is no income limit to use this strategy, having pre-tax assets may make it difficult or impossible to do a backdoor Roth conversion. If you have any questions or uncertainty about the process, it is always worth consulting a tax professional or financial advisor with backdoor Roth experience.