What Is a Backdoor Roth IRA and How Does It Work?
A backdoor Roth IRA (individual retirement account) is a loophole strategy for high earners to qualify for a Roth IRA. The process involves converting a traditional IRA into a Roth IRA to allow “backdoor” access. It's important to understand how to bypass eligibility rules and how backdoor Roth IRAs are taxed before considering if this approach aligns with your retirement goals.
- Written by Lindsey Crossmier
Lindsey Crossmier is an accomplished writer with experience working for The Florida Review and Bookstar PR. As a financial writer, she covers Medicare, life insurance and dental insurance topics for RetireGuide. Research-based data drives her work.Read More
- Edited ByLamia Chowdhury
Lamia Chowdhury is a financial content editor for RetireGuide and has over three years of marketing experience in the finance industry. She has written copy for both digital and print pieces ranging from blogs, radio scripts and search ads to billboards, brochures, mailers and more.Read More
- Reviewed ByStephen Kates, CFP®
Stephen Kates, CFP®
Certified Financial Planner™ Professional and Founder of Clocktower Financial Consulting
Stephen Kates is a Certified Financial Planner™ professional and personal finance expert with over a decade of experience working with individuals and families who need help with their finances. With experience as a financial advisor for two of the largest financial firms in the country, Stephen has worked with hundreds of clients to build comprehensive financial plans to grow and protect their wealth.Read More
- Published: May 3, 2023
- Updated: October 6, 2023
- 6 min read time
- This page features 9 Cited Research Articles
- Edited By
- Create a backdoor Roth IRA by converting a traditional IRA into a Roth IRA.
- Backdoor Roth IRAs allow you to qualify for a Roth IRA, no matter what your income is, and skip RMDs.
- A backdoor Roth IRA can affect your taxes and increase the taxable amount of your Social Security benefits.
What Is a Backdoor Roth IRA?
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.
Backdoor Roth IRAs are one of the most popular topics in personal finance blogs and podcasts, but it's often more complicated than presented. This strategy is only beneficial for high earning individuals or couples. Second, if there are any pre-tax traditional IRA assets, it is recommended to convert those completely first, before making any post-tax traditional contributions.
Pros and Cons of Backdoor Roth IRAs
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.
- You’ll need to wait at least five years before making a withdrawal, no matter what age you are
- If you fail to file form 8606 with your taxes, a backdoor Roth IRA could make you owe taxes
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.
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Eligibility Criteria for a Backdoor 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.
How To Set Up a Backdoor Roth IRA
There are three steps to set up a backdoor Roth IRA.
- Open a traditional IRA and make a contribution. If you already have a traditional IRA with funds in it that are pre-tax (either from deductible contributions or from a pre-tax rollover) then you will have a taxable conversion when moved to a Roth IRA. Your pre-tax money should be converted before making post-tax contributions to avoid a confusing pro-rata conversion where part of the conversion is taxable and part of it is not.
- Convert your contribution to a Roth IRA. If you don’t have a Roth IRA yet, open one to complete the conversion. You’ll be allowed to open this account as long as it’s known the account is for conversion purposes.
- If your contributions from your traditional IRA weren’t taxed, prepare to pay taxes on the funds rolled over into the backdoor Roth IRA.
Considerations for Individuals Nearing or in Retirement
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.
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Backdoor Roth IRA FAQs
Editor Malori Malone contributed to this article.
9 Cited Research Articles
- Wohlner, R. (2023, April 16). What Is A Backdoor Roth IRA? Your Complete Guide 2023. Retrieved from https://time.com/personal-finance/article/backdoor-roth-ira/
- Internal Revenue Service. (2023, February 21). Traditional and Roth IRAs. Retrieved from https://www.irs.gov/retirement-plans/traditional-and-roth-iras
- Internal Revenue Service. (2022, October 26). Amount of Roth IRA Contributions That You Can Make For 2023. Retrieved from https://www.irs.gov/retirement-plans/amount-of-roth-ira-contributions-that-you-can-make-for-2023
- H&R Block. (2022, September 13). Rules for Traditional and Roth IRA Contributions. Retrieved from https://www.hrblock.com/tax-center/income/retirement-income/traditional-and-roth-ira/
- Rodeck, D. (2022, July 26). Retirees, Make the Most of a Roth's Back Door. Retrieved from https://www.kiplinger.com/retirement/604962/retirees-make-the-most-of-a-roths-back-door
- Internal Revenue Service. (2022, June 16). Rollovers of Retirement Plan and IRA Distributions. Retrieved from https://www.irs.gov/retirement-plans/plan-participant-employee/rollovers-of-retirement-plan-and-ira-distributions
- Wells Fargo. (2022). Pro-Rata Rule for After-Tax Money in an IRA. Retrieved from https://www08.wellsfargomedia.com/assets/pdf/personal/investing/retirement/taxes-and-retirement/pro-rata-rule.pdf
- Bank of America. (n.d.). Thinking of Converting to a Roth IRA? Retrieved from https://www.merrilledge.com/article/thinking-of-converting-to-roth-ira
- Wells Fargo. (n.d.). Converting to a Roth IRA. Retrieved from https://www.wellsfargo.com/investing/retirement/ira/roth-ira-conversion/
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