How To Do a Backdoor Roth IRA, Correctly

There are many ways you can plan for retirement. Some options are better than others in maximizing your tax advantages. Knowing how to do a backdoor Roth IRA (correctly) is one option that could work for you.  

Traditional IRA and Roth IRA contribution limits often pose restrictions for high-income earners. The backdoor Roth IRA is an alternative route to access the benefits of a Roth IRA—regardless of income level. 

In financial circles, the backdoor Roth IRA strategy is a savvy method for high-income earners to access the benefits of a Roth IRA. However, it has historically come with some baggage. Regulators and the public have been skeptical that it’s “a wealthy person’s loophole.” 

In truth, the skepticism wasn’t unfounded—but not because of its benefits. Financial advisors and CPAs grappled with the absence of explicit backdoor Roth IRA contributions rules: Unclear guidelines led to wariness about potential legal and regulatory hazards. As a result, many high-income individuals missed out on the opportunity to harness the full potential of a Roth IRA.  

What is a backdoor Roth IRA?

A backdoor Roth IRA (a non-deductible IRA contribution converted to a Roth IRA) is a financial strategy individuals use to contribute to a Roth IRA when their income exceeds the limits set by the IRS for direct contributions to a Roth IRA.  The term “backdoor” reflects the indirect nature of this contribution method.  

As of 2024, single filers with modified adjusted gross income (MAGI) above $161,000 and married couples above $240,000 are ineligible to contribute to a Roth IRA directly.    

How do you make a backdoor Roth IRA contribution?

The first step in the backdoor Roth IRA strategy involves making a nondeductible contribution to a traditional IRA. There are no income limits for making nondeductible contributions to a traditional IRA. 

After contributing to the traditional IRA, the individual converts the funds to a Roth IRA. This conversion involves transferring the funds from the traditional IRA to the Roth IRA. Since the individual has already paid taxes on the non-deductible contribution to the traditional IRA, the conversion typically incurs little to no additional tax liability, assuming there are no earnings on the contributed amount between the time of contribution and conversion. This also assumes the IRA has a $0 balance in the account before the non-deductible IRA contribution is made.   

What are backdoor Roth IRA contribution limits, and when are the deadlines?

The backdoor Roth IRA strategy doesn’t have specific contribution limits separate from the traditional IRA and Roth IRA contribution limits set by the IRS.  The contribution limits for a backdoor Roth IRA tie to those of a traditional IRA and Roth IRA, which can change yearly.  As of 2024, individuals under 50 can contribute up to $7,000 annually to an IRA; Those 50 and older can make catch-up contributions of up to $8,000 annually.  

The deadline for making a non-deductible IRA contribution is typically the same deadline for filing federal income tax returns for that tax year, usually April 15 of the following year.  

Contributions for a specific tax year must be made by the tax filing deadline, regardless of any extensions. For example, contributions for the 2024 tax year must be made by April 15, 2025. If you file for an extension for your tax return, the deadline for making contributions is still April 15, not the extended deadline. 

There is no deadline for converting non-deductible IRA contributions to the Roth IRA. Most advisors recommend converting shortly after the non-deductible IRA contribution to avoid incurring any earnings in the IRA. The Roth conversion taxes earnings.    

Who should consider making a contribution?

Due to high-income levels, the backdoor Roth IRA contribution strategy can benefit certain individuals, particularly those ineligible to contribute directly to a Roth IRA. Here are some scenarios in which making a backdoor Roth IRA contribution might be advantageous:  

• High-Income Earners: Individuals whose income exceeds the limits for direct Roth IRA contributions can use the backdoor strategy to access the tax advantages of a Roth IRA. 
• Those Seeking Tax Diversification: Diversifying retirement savings across different types of accounts, such as traditional IRAs, Roth IRAs, and employer-sponsored plans, can provide flexibility in retirement tax management. The backdoor Roth IRA strategy allows individuals to enhance their tax diversification by contributing to a Roth IRA. 
• Investors Expecting Higher Taxes in Retirement: If you anticipate being in a higher tax bracket during retirement, contributing to a Roth IRA through the backdoor strategy can be advantageous. Roth IRA withdrawals in retirement are tax-free, providing tax-free income during retirement years. 
• Younger Investors: Individuals with a long-time horizon until retirement can benefit from the tax-free growth potential of a Roth IRA. They can maximize the compounding effect of tax-free earnings over time by utilizing the backdoor Roth IRA strategy early in their careers. 
• Those Wanting to Leave Tax-Free Inheritances: Roth IRAs offer unique advantages for estate planning, as distributions to beneficiaries are typically tax-free. Making backdoor Roth IRA contributions can be a strategy for individuals looking to leave tax-free inheritances to their heirs. 
• Investors Concerned About Future Tax Law Changes: Given the uncertainty surrounding future tax laws, some individuals may prefer to hedge against potential tax increases by contributing to a Roth IRA through the backdoor strategy. 

Tax considerations when making a backdoor Roth IRA contribution (pro-rata rule)

The pro-rata rule comes into play if you have other traditional IRA assets besides the nondeductible IRA contributions you are converting to a Roth IRA. This rule stipulates that any conversion from a traditional IRA to a Roth IRA is considered to include a proportional amount of both pre-tax and after-tax (non-deductible) funds based on the total balance of all traditional IRAs. As a result, you may owe taxes on a portion of the conversion, even if you only intended to convert nondeductible contributions. 

To avoid the pro-rata rule when making backdoor Roth IRA contributions, one common strategy is to ensure that there are no pre-tax funds in any traditional IRA accounts at the time of conversion. Consider: 

• Utilizing an employer-sponsored plan: If you have access to an employer-sponsored retirement plan like a 401(k) that allows incoming rollovers from traditional IRAs, consider rolling over any pre-tax IRA funds into the employer plan. This can effectively segregate pre-tax funds from after-tax funds, allowing for a clean conversion of only after-tax funds to the Roth IRA. 
• Convert all pre-tax IRA funds to Roth IRA: If you have pre-tax funds in traditional IRA accounts, consider converting them to Roth IRA before executing the backdoor Roth IRA strategy. This would eliminate pre-tax funds from your traditional IRA accounts, allowing you to convert only after-tax funds without triggering the pro-rata rule. Remember that when converting pre-tax IRA funds into a Roth IRA, you pay tax on the pre-tax contributions and earnings in the year of the conversion.

Tax compliance when making a backdoor Roth IRA contribution

Ensuring tax compliance when executing backdoor Roth IRA contributions is crucial to avoid potential penalties or complications with the IRS. Here are some key considerations to ensure tax compliance: 

• Reporting Nondeductible Contributions: When making nondeductible contributions to a traditional IRA as part of the backdoor Roth IRA strategy, you must report these contributions accurately on your tax return. Form 8606, “Nondeductible IRAs,” reports nondeductible contributions to traditional IRAs. 
• Reporting Roth IRA Conversions: Any conversions from a traditional IRA to a Roth IRA must also be reported on your tax return. Form 8606 is also used to report Roth IRA conversions. This form helps track your traditional IRA’s basis (after-tax contributions) and ensures you’re not taxed twice on the same income.   

What is a mega backdoor Roth, and how does it vary from a backdoor IRA?

The mega backdoor Roth IRA allows individuals to make additional after-tax contributions to their employer-sponsored retirement plans, such as a 401(k) or 403(b), beyond the traditional contribution limits.  

These after-tax contributions are converted directly to a Roth, providing an opportunity to maximize Roth IRA savings beyond the standard contribution limits. Not all employers allow these after-tax contributions, so it is important to check with your plan provider before considering this strategy further. 

In contrast, a backdoor Roth IRA involves making nondeductible contributions to a traditional IRA and then converting those funds to a Roth IRA. Often, individuals use it when they are ineligible to make direct contributions to a Roth IRA due to income limitations.  

While both strategies involve converting funds to a Roth IRA, the mega backdoor Roth specifically utilizes after-tax contributions to employer-sponsored plans, allowing for potentially higher contribution amounts than the backdoor Roth IRA. 

Consider your goals, tax situation, and retirement planning needs

Consult with a financial advisor and tax professional who can provide personalized guidance based on your specific circumstances. Additionally, ensuring compliance with IRS regulations when executing the backdoor Roth IRA strategy is crucial.   

Connect with one of our advisors to determine if a backdoor Roth is a prudent retirement savings strategy within the scope of your financial plan.