Backdoor Roth IRA Loophole Dodged the Axe - SmartAsset (2024)

President Biden signed the Inflation Reduction Act into law in August 2022. This is a trimmed-down version of the Build Back Better Act, a $1.75 trillion social spending initiative that had struggled to get votes in Congress. The expanded bill initially proposed ending a lucrative retirement account loophole known as abackdoor Roth IRA, which benefits high-income earners. Here’s what you need to know.

Whether you have a traditional or a Roth IRA, you may want towork with a financial advisor on how best to handle such accounts to maximize your retirement assets.

What Is a Backdoor Roth IRA?

A backdoor Roth IRA, which came into effect in 2010, permits account holders to work around income tax limits by converting what was originally atraditional IRAinto aRoth IRA.For people with a modified adjusted gross income above certain levels, there are limits on direct Roth IRA contributions. Under current tax law, individuals making more than $153,000 in tax year 2023 (up from $144,000 in 2022) are barred from contributing to a Roth IRA, where retirement savings grow tax-free.

However, workers who exceed this income threshold have been permitted to convert their pre-tax contributions into a Roth IRA. After they pay income taxes on the initial contributions and gains, their retirement savings grow tax-free and are no longer subject torequired minimum distributions(RMDs).

The Once-and-Future Loophole

Democrats on the House Ways and Means Committee initiallyproposed eliminating the backdoor Roth IRA strategy to help pay for Biden’s Build Back Better bill, which was worth then $3.5 trillion. But after moderate Democrats, and Republican lawmakers, opposed the high cost of the bill, a scaled-back proposal trimmed down the new draft of the legislation to $1.75 trillion.

One such feature was the proposal to eliminate the backdoor Roth IRA strategy. Before being removed from Build Back Better, the bill would have stopped Roth conversionsfor both IRAs and employer-sponsored plans for single taxpayers and married taxpayers filing separately with taxable income greater than $400,000, married taxpayers filing jointly with taxable income above $450,000 and heads of household with taxable income over $425,000. The elimination of the backdoor Roth IRA would have taken effect after Dec. 31, 2021.

House Democrats ultimately approved the Inflation Reduction Act in August 2022, which is worth less than a quarter of $3.5 trillion Build Back Better Act ($740 billion). Lawmakers left out some proposals that had been initially proposed as part of a plan to help pay for the legislation. One of those proposals excluded was eliminating the backdoor Roth IRA.

Bottom Line

With the now 12-year-old loophole off the chopping block, the pressure many taxpayers planning for retirement were feeling to take advantage of it is gone. This means that if you are ineligible to put money into a Roth IRA, you can still do so into a traditional IRA and then convert that money into a Roth so that it can grow tax-free.

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