What Is a Backdoor Roth IRA and How Does It Work?

A backdoor Roth IRA isn’t a type of IRA — it’s a strategy for high earners to qualify for opening a Roth IRA when they typically wouldn’t be permitted due to income limits.

Think of a backdoor Roth IRA as a steppingstone. You’d make after-tax contributions to a traditional IRA, which doesn’t have income limits, and then convert the traditional IRA into a Roth IRA.

If you’re considering a backdoor Roth IRA as a part of your retirement investment plan, you might want to act soon. According to Kiplinger, Democratic lawmakers were looking into restricting or eliminating the backdoor Roth IRA in 2022. However, as of April 24, 2023, backdoor Roth IRAs are still permitted. 

It’s in your best interest to carefully consider the pros and cons of a backdoor Roth IRA before making any significant decisions. Involving a financial advisor can help you determine if a backdoor Roth IRA fits your needs.

While the main advantage of a backdoor Roth IRAs is to reap the benefits of a Roth IRA while sidestepping the eligibility rules, there are other pros and cons to consider.

The backdoor Roth IRA offers the same tax advantages as a regular Roth IRA, allowing you to withdraw money tax-free during your retirement years.

Because of this, you’ll have to pay taxes on any money you converted to your Roth IRA that you haven’t already paid taxes on.

For example, say you contribute $5,000 to a traditional IRA, and claim a deduction for the $5,000 on your tax return that year. If you convert that money to a Roth IRA, you’ll owe taxes on the $5,000.

However, if you make after-tax contributions to your traditional IRA, the funds won’t be taxed once transferred to the Roth IRA.

Almost everyone is eligible for a backdoor Roth IRA, according to Kiplinger. First, you need to open a traditional IRA, which is available for anyone with an earned income. Traditional IRAs have no income limit and you open one at any age.

However, unlike a traditional IRA, a Roth IRA has income limits.

If you make above $153,000, you can’t make Roth IRA contributions in 2023. If you’re married and filing jointly, that limit increases to $228,000.

To avoid these limits, create a backdoor Roth IRA by converting your traditional IRA into a Roth IRA.

There are no eligibility requirements to convert your traditional IRA into a Roth IRA. In fact, this type of conversion is excluded from the IRS’s one-rollover-per-year rule.

There are three steps to set up a backdoor Roth IRA.

Retirees should be wary of the pro-rata rule for Roth conversions. The pro-rata rule, determined by the IRS, looks at the percentage of pre-tax versus after-tax dollars in your traditional IRA.

This percentage determines what will be taxable after you make a backdoor Roth IRA conversion. If a large portion of your roll over is tax deductible, you may want to consider other options.

You’re also required to wait five years before withdrawing any funds from your Backdoor Roth IRA. A backdoor Roth IRA may not be the best fit for your retirement plan if you predict you’ll need to tap into your funds before then.

Also, consider when you may need to tap into your Social Security benefits. If you convert your traditional IRA into a Roth IRA, more of your Social Security benefit becomes taxable. Check the tax rules for Social Security before completing the roll over.

Editor Malori Malone contributed to this article.