While most people can contribute directly to a Roth IRA, the IRS defines income limits that prevent high income earners from doing just that. Enter the backdoor Roth IRA—a colloquial term for the conversion of a traditional IRA to a Roth IRA which allows high income earners to indirectly fund a Roth individual retirement account.
We all know the awesome benefits of a Roth IRA: money grows tax free and you pay no taxes on it in retirement. It’s no wonder that high income earners are willing to jump through a few hoops to access Roth IRAs. A backdoor Roth IRA essentially allows people with high incomes to avoid Roth IRA contribution limits.
Here is a list of 5 essential backdoor Roth IRA facts that you should know about.
1. A Backdoor Roth IRA is Essentially a Rollover of a Traditional IRA
Simply put, a backdoor Roth IRA is the act of rolling over a traditional IRA to a Roth IRA. While just about anyone with a traditional IRA can execute a backdoor Roth IRA conversion, it makes the most sense for high income earners. You see, the IRS establishesRoth IRA contribution limitsbased on your salary. Those who make over a certain salary are not eligible to contribute directly to a Roth IRA; however, they can fund a Roth IRA using this backdoor method.
2. Roth IRA Contribution Limits Dictate The Need for a Backdoor Roth IRA
Single, head of household, or married filing separately not living with your spouse
Less than $122,000
$6,000
$122,000 to $137,000
Reduced amount*
$137,000 or more
$0
*useIRS Worksheet 2-2to determine your reduced Roth IRA contribution limit
Not everyone needs to fund their Roth IRA through the backdoor method. A backdoor Roth IRA is only necessary for high income earners according to the2019 Roth IRA Contribution Limitstable above. Anyone who has a Roth IRA contribution limit of $0 or a reduced amount can fund a Roth IRA via the backdoor method.
3. Immediately Rollover a Traditional IRA to Roth IRA to Avoid Taxes
In order to minimize taxes, it is recommended that you convert your traditional IRA to a Roth IRA as soon as possible after contributing. Whether you make periodic deposits into a traditional IRA throughout the year or one large lump sum contribution, the sooner you rollover from traditional to Roth, the better.
You must pay tax on any traditional IRA earnings when converting to a Roth IRA. Therefore, it makes sense to fund your Roth IRA through the backdoor method immediately after contributing to your traditional IRA. In other words, rollover your traditional IRA funds to a Roth IRA account right after making any contributions.
Theone-rollover-per-yearrule does not apply to rollovers from traditional IRAs to Roth IRAs meaning you can technically fund your backdoor Roth IRA multiple times per year. Although you have this freedom and flexibility, be sure to convert from traditional to Roth as soon as possible after funding your traditional IRA to avoid paying taxes on any gains.
4. You Have Until April 15, 2020 to Make a 2019 IRA Contribution
Contrary to popular belief, the IRA contribution deadline is April 15th of every year, not December 31st. This means you can make 2019 IRA contributions until April 15, 2020. In other words, you have a total of 15.5 months between January 1, 2019 and April 15, 2020 to contribute to your IRA accounts.
Because there is an extra step of rolling over funds and since you want to avoid paying taxes on gains, it is recommend that you fund your traditional IRA in a lump sum sometime before the April tax deadline and quickly convert theses funds into a Roth IRA via the backdoor method.
5. You Must Have Earned Income to Fund a Backdoor Roth IRA
If you don’t earn any income during the year, you are not eligible to contribute to an IRA. Earned income does not include:
Additionally, if your income is less than the Roth IRA contribution limit, you can only contribute as much as you earn. For example, the Roth IRA contribution limit in 2019 is $6,000. If you only earn $3,500 in 2019, you can contribute at most $3,500 to an IRA.
Although I don’t earn enough money (yet) to need a backdoor Roth IRA, I am still very much interested in this topic and the topic ofretirement savings and investingin general. Do you have a backdoor Roth IRA or planning on contributing to one? I’d love to hear from you in the comments below.
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.
If you do a backdoor Roth IRA conversion every year, you must wait five years to tap each portion you convert. Otherwise, you risk paying additional penalties on money that's already been taxed. There are exceptions to this requirement, though, if you're 59 ½ or older or if you become disabled or die.
A “backdoor” Roth IRA allows high earners to sidestep the Roth IRA's income limits by converting nondeductible traditional IRA contributions to a Roth IRA. That typically requires you to pay income taxes on funds being rolled into the Roth account that have not previously been taxed.
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.
Bottom Line. 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.
The backdoor Roth IRA strategy is not a tax dodge. When you transfer the assets of a traditional IRA to a Roth IRA, you owe taxes on any funds—the principal, earnings, and appreciation—that have not been taxed previously.
The first step is to transfer existing pre-tax IRA funds into the employer plan like a 401(k). As long as the taxpayer does not hold any pre-tax IRA funds at the end of the year, a backdoor Roth contribution could be executed without having to worry about the pro-rata rule.
For 2024, total 401(k) contributions (pre-tax, after-tax, employer matching contributions, and any other non-elective employer contributions) are capped at $69,000, up from $66,000 for 2023. If you're 50 or older, the limit is $76,500, up from $73,500 in 2023.
The point of a Roth IRA is that it's already taxed money that grows tax-free. So, to convert your traditional IRA to a Roth IRA you'll have to pay ordinary income taxes on your traditional IRA contributions in the year of the conversion before they “count” as Roth IRA funds.
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.
You can shift money from a traditional IRA or 401(k) into a Roth IRA by doing a Roth IRA conversion. The amount you convert is added to your gross income for the tax year in which you make the switch. Tax rates range from 10% to 37%, and the conversion could push you into a higher tax bracket.
In that case, a “backdoor Roth conversion IRA” could allow one or both spouses to take advantage of getting more dollars into a Roth IRA without paying any taxes. (This can be true for after-tax contributions in a 401(k) plan too).
A "mega backdoor Roth" strategy can potentially allow some people to save more in a Roth IRA and/or Roth 401(k) than they otherwise would be able to. Whether or not the strategy is available to you depends on the specific features of your 401(k) or other workplace retirement plan.
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.
A backdoor Roth IRA lets you convert a traditional IRA to a Roth, even if your income is too high for a Roth IRA. By Elizabeth Ayoola. Elizabeth Ayoola. Writer | Retirement, credit, wellness. Elizabeth Ayoola is a NerdWallet personal finance writer.
The backdoor Roth remains a legal option for now, but a retooled Build Back Better Act could come back and close the loophole. It might even be retroactive, impacting backdoor Roth conversions that have already occurred, which has some investors questioning whether it remains a viable strategy.
Introduction: My name is Kimberely Baumbach CPA, I am a gorgeous, bright, charming, encouraging, zealous, lively, good person who loves writing and wants to share my knowledge and understanding with you.
We notice you're using an ad blocker
Without advertising income, we can't keep making this site awesome for you.
