Deep Dives
What is a "Backdoor" Roth Contribution?

Ever heard of a backdoor Roth IRA? Sounds so sneaky! A backdoor Roth IRA isn’t a type of retirement savings account, but rather a strategy that allows individuals over the income limit for an IRA to still save a few thousand dollars in a tax-advantaged retirement account.

What is a "Backdoor" Roth Contribution?
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July 5, 2022

Ever heard of a backdoor Roth IRA? Sounds so sneaky! A backdoor Roth IRA isn’t a type of retirement savings account, but rather a strategy that allows individuals over the income limit for an IRA to still save a few thousand dollars in a tax-advantaged retirement account.

As a quick refresher, a Roth IRA allows you to contribute non-tax-deducted money into a retirement account. Once you reach the age of 59 ½ (and have held the account for at least 5 years), the funds can be withdrawn tax free. If you are in a lower tax bracket today than you anticipate during retirement, this may be tax-advantageous for you. Or, if you do not intend to use all your retirement savings during your lifetime, it is tax-advantageous for your non-spouse heirs to inherit a Roth IRA over a traditional IRA account. 

However, there are income limits that prohibit some people from contributing to Roth IRAs. For higher-earning individuals, the amount you can contribute to a Roth IRA begins to “phase out” until the ability to contribute is eliminated completely. 

If you fall into this category and have thought you cannot take advantage of the benefits of a Roth IRA, not so fast! Here’s where the backdoor Roth comes into play. You can make a non-deductible contribution to a traditional IRA account which creates “basis” in the account (essentially contributing with after-tax money). If you have basis in your traditional IRA that is equal to the account value (meaning no gains), you can convert the traditional IRA to a Roth IRA without triggering a taxable event. 

Once the funds are in your Roth IRA account, you can invest them to your target allocation and enjoy the same tax benefits as if you had made the Roth IRA contribution directly. Pretty cool, right? 

What’s the catch? 

The IRS considers the combined total of all your traditional IRA accounts when determining the taxability of a Roth conversion. They will apply the basis pro-rata to the amount converted. For example, let’s say you have the following accounts:

  • You made a non-deductible contribution of $6,000 to Traditional IRA #1, therefore you have basis in this account. 
  • Your Rollover Traditional IRA #2 was funded when you rolled your old 401k from a previous employer into this IRA account. The contributions to the 401k account were deducted in the year they were made (i.e. this is pre-tax money) therefore you do not have any basis in this IRA Account #2.

If you were to try to convert 100% of traditional IRA #1 to a Roth IRA, the IRS would aggregate your traditional IRA accounts (both IRA #1 and #2 listed above) and apply the basis for the aggregated accounts pro-rata to the amount you converted. You have $12,000 total traditional IRA assets, with $6,000 of basis; therefore 50% of your conversion would be taxable. In this case, you would be taxed on $3,000 (.5 X $6,000 without basis from #2) at ordinary income tax rates if you converted all of Traditional IRA #1. 

What if I already have Traditional IRA assets?

For this reason stated above, this strategy is best executed if no other traditional Pre-tax IRA assets exist. However, if you have existing traditional IRA assets that prevent you from doing a tax-free Roth conversion, consider rolling your existing traditional IRA into your current employer’s 401k account. Once the assets are in a 401k account, they are no longer included by the IRS when aggregating your IRA accounts. 

So who should use this “backdoor” strategy?

The first type of person that would benefit from this strategy is someone who is making above the AGI limits and has already contributed the maximum allowed to a company retirement plan. Utilizing the Backdoor Roth contribution allows them to sock away an additional $6,000 in a tax beneficial way. 

The second type of person that would benefit from this would be someone who is not covered by a company retirement plan but their spouse does have access to one. If their joint income is above the MAGI limits and one spouse has access to an employer plan they cannot benefit from a Deductible IRA contribution therefore they should convert this to a Roth in the manner we are describing.  

The deadline for making your annual contribution is the tax filing deadline for that year (i.e. for 2020 the contribution must be made by April 15th, 2021). We tell you exactly how to execute this strategy here.

Related Deep-Dive
How to Make a "Backdoor" Roth Contribution
A backdoor Roth contribution is a great way for higher-income individuals to take advantage of additional tax sheltered savings for retirement.
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Heather Comella