What is backdoor Roth IRA?
A backdoor Roth IRA is a conversion that allows high earners to open a Roth IRA despite IRS-imposed income limits. Basically, you put money you've already paid taxes on in a traditional IRA, then convert your contributed money into a Roth IRA, and you're done.
Cons: All or part of a backdoor Roth IRA conversion could be a taxable event. You may have to pay federal, state, and local taxes on converted earnings and deductible contributions. Conversions could kick you into a higher tax bracket for the year.
Understanding Backdoor Roth IRAs
The limits are as follows: For 2023: Between $138,000 and $153,000 for single filers and between $218,000 and $228,000 for joint filers. For 2024: Between $146,000 and $161,000 for single filers and between $230,000 and $240,000 for married couples filing jointly4.
Another option, if your employer's plan offers it, is the mega backdoor Roth. Under this option you would make after-tax contributions into your employer's 401(k) plan. For 2024 the limit for these after-tax contributions is $46,000.
They simply move their money from a traditional IRA to a Roth IRA. This strategy is known as a Roth conversion. It's also called a backdoor Roth IRA conversion because it allows people who aren't ordinarily eligible for a Roth IRA due to their income to set one up by sneaking in through the back door, so to speak.
Backdoor Roth IRA income limits
The phaseout occurs between $146,000 and $161,000 for single filers and $230,000 and $240,000 for joint filers in 2024. The backdoor method allows those with higher incomes who can't contribute in the typical manner to still take advantage of a Roth IRA.
You won't pay double taxes with a backdoor Roth, but you may end up paying some taxes depending on your financial situation. Talk with your financial advisor before making this move to minimize taxes and maximize retirement benefits.
Backdoor Roth IRA contributions can equate to significant tax savings over time, as Roth IRA distributions, unlike traditional IRA distributions, are not taxable.
The IRS does not put a cap on the number of Roth conversions per year you can make. You could convert all of your savings to a Roth IRA in one go or spread them out over several conversions throughout the year. You can also complete Roth IRA conversions in multiple years, which could make sense in certain situations.
A mega backdoor Roth takes it to the next level. It's for people who have a 401(k) plan at work. They can put up to $46,000 of post-tax dollars in 2024 into their 401(k) plan and then roll it into a mega backdoor Roth, which is either a Roth IRA or Roth 401(k).
Is a backdoor Roth smart?
Some high-profile personal finance commentators are big fans of the “backdoor Roth IRA.” I'm not — at least not for high earners — and here's why: If you're making enough money to be considering a backdoor Roth, there are likely higher-impact, less administration-intensive ways to minimize your tax burden.
A backdoor Roth can be created by first contributing to a traditional IRA and then immediately converting it to a Roth IRA to avoid paying taxes on any earnings or having earnings that put you over the contribution limit.
While it doesn't look like they'll be eliminated in 2024, the future of the Backdoor Roth IRA remains a target of proposed legislation. Some legislative efforts have already been taken to limit Roth IRAs or to change tax brackets and RMDs in the future.
The backdoor Roth may not last forever
If the IRS decides that the loophole is a violation, you could owe a 6% excise tax for overfunding your Roth. And if restrictions do come into play at some point, they could require backdoor Roth converters to pay a penalty, or they might include a grandfather clause.
A backdoor Roth IRA isn't a type of IRA; it's a strategy that converts contributions in a traditional IRA into a Roth IRA. It's useful for high earners who can't contribute to a Roth IRA because of income limits but still want its tax-advantages.
The Roth IRA five-year rule says you cannot withdraw earnings tax-free until it's been at least five years since you first contributed to a Roth IRA account.
If you're married, your spouse can also do the backdoor Roth, even if he or she has no earned income. You must have at least $14,000 of earned income between the two of you (or $15,000 or $16,000 if one or both of you is at least 50 years old), but all of the income can come from one person.
How Does a Backdoor Roth IRA Work? Here's how it works. Open a new traditional IRA, make non-deductible contributions and then convert the account into a Roth IRA. There are no income thresholds limiting who can make nondeductible IRA contributions, although you still need to obey the annual IRA contribution limits.
If you file taxes as a single person, your Modified Adjusted Gross Income (MAGI) must be under $153,000 for tax year 2023 and $161,000 for tax year 2024 to contribute to a Roth IRA, and if you're married and filing jointly, your MAGI must be under $228,000 for tax year 2023 and $240,000 for tax year 2024.
Mega backdoor Roth cons
Five-year rule: Much like the backdoor Roth, money generally must sit in a Roth account for at least five years before you can withdraw it penalty- and tax-free.
Do I need to report backdoor Roth on taxes?
The tax requirements for a backdoor Roth IRA involve reporting nondeductible contributions to a traditional IRA and subsequent conversions to a Roth IRA on Form 8606. Failing to do so, could cost you more money in IRS penalties and additional taxes on the converted amount.
A mega backdoor Roth refers to a strategy that can potentially allow some people who would be ineligible to contribute to a Roth account, based on their income or contribution limits, to transfer certain types of 401(k) contributions into a Roth—including a Roth IRA and/or Roth 401(k).
Mega backdoor Roth conversions can be a 'no brainer' for higher earners, expert says. Roth individual retirement accounts offer tax-free growth and other benefits, but some investors earn too much for direct contributions.
You have to wait longer for the tax-savings payoff with a Roth IRA versus a traditional IRA. You pay taxes on the money before it goes into the account, meaning no tax deduction.
No, the backdoor Roth is not considered illegal. The IRS does not classify the backdoor Roth as a form of tax evasion but could best be described as a form of tax avoidance. If you have any misgivings about this financial maneuver in a specific situation, you can consult a more experienced tax professional.
