A backdoor Roth is a method for those earning too much to make a direct contribution to a Roth IRA to contribute to a traditional IRA and then convert that money to a Roth IRA account. With a backdoor Roth, an after-tax contribution is made to a traditional IRA. This money is then converted to a Roth IRA. Depending on factors discussed below, some or all of the conversion may be tax-free.
Why do a backdoor Roth IRA conversion?
The ability to make direct contributions to a Roth IRA are limited for those who are above a certain income level. For 2022, these income limits are:
| Tax filing status | Income level | Contribution limits |
|---|---|---|
Single or head of household or qualifying widow(er) | Less than $129,000 | No limits |
$129,000 to $144,000 | Contributions are phased out | |
$144,000 or more | No contributions allowed | |
Married filing jointly | Less than $204,000 | No limits |
$204,000 to $214,000 | Contributions are phased out | |
$214,000 or more | No contributions allowed | |
Married filing separate | Less than $10,000 | Contributions are phased out |
$10,000 or more | No contributions allowed |
These income limits are based on your modified adjusted gross income (MAGI) for the year. MAGI is your adjusted gross income from your tax return with certain deductions added back.
For those whose income is too high and their ability to contribute to a Roth IRA is reduced or eliminated for the year, a backdoor Roth IRA conversion offers a way to fund a Roth IRA.
How does a backdoor Roth IRA work?
A backdoor Roth IRA starts with an after-tax contribution to a traditional IRA account. The account holder then does a conversion to a Roth IRA account. If you don’t have a traditional IRA and/or a Roth IRA account already open, you will need to establish an account or accounts before moving forward with the backdoor Roth process.
After making the after-tax contribution to the traditional IRA account, you would then convert the amount of the contribution to a Roth IRA.
Taxes may or may not be due on the amount converted via the backdoor Roth IRA conversion. See below for a discussion of the potential tax implications.
Backdoor Roth IRA contribution limit
The contribution limit to initiate a backdoor Roth via an after-tax contribution to a traditional IRA is the annual IRA contribution in effect in the year you want to do this. For 2022 the IRA contribution limits are $6,000 plus an extra $1,000 catch-up contribution for those who are 50 or over.
These $6,000 and $7,000 limits apply to contributions made to all IRA accounts. For example, if you are 40 years old and make a $3,000 pre-tax contribution to a traditional IRA account, you would only be able to make an additional $3,000 contribution to a traditional IRA on an after-tax basis.
If your goal is to do the largest backdoor Roth IRA conversion possible then you will want to make your entire IRA contribution to a traditional IRA on an after-tax basis and then use this money to complete the Roth conversion.
To be clear, there are no limits on the amount that can be converted from a traditional IRA to a Roth IRA in a given year. The only limit would, of course, be the amount available to convert in one or more traditional IRA accounts. Obviously the larger the conversion amount the more you might have to pay in taxes on the conversion.
Contribution limits, in this case, only apply to the amount of the after-tax contribution to a traditional IRA in a given tax year that you will earmark for a backdoor Roth IRA conversion.
Backdoor Roth IRA taxes
Generally a Roth IRA conversion will be subject to taxes in the year of the conversion to the extent that the money converted consists of money that was originally contributed to the traditional IRA account on a pre-tax basis. Additionally, any part of the conversion that is attributable to earnings on the money invested in the traditional IRA would potentially be subject to taxes as well.
The taxation of a conversion done via a backdoor Roth IRA will vary. The tax burden could be as low as zero.
In a situation where an individual makes an after-tax contribution to a traditional IRA and has no other money in a traditional IRA account, then the conversion of the money contributed to the traditional IRA would be 100% tax free as long as the contributions did not earn any interest or gains from investments from the time the contribution was made until the time of the conversion.
For example, you are 40 years old and contributed $6,000 after-tax to a traditional IRA. If you have no other assets in a traditional IRA, you have not received any type of interest or gain on the money contributed, then the entire $6,000 would be converted to a Roth IRA with no taxes due.
Let’s use the same scenario, only you wait a few months and your account has earned $300 in interest bringing the total balance to $6,300. If you do the backdoor Roth conversion at this point then approximately 95.3% of the conversion (the $6,000) would be tax free and you would owe any applicable federal taxes on the $300 or 4.7% of the balance converted.
As far as state income taxes, this will vary by state in terms of the tax rate and if they tax Roth IRA conversions.
Taxes and the pro-rata rule
In the situation where you have other money in traditional IRA accounts in addition to the amount of the after-tax contribution made in the current year to do a backdoor Roth IRA, the tax situation can become a bit more complicated due to the pro-rata rule.
The pro-rata rule says that any Roth IRA conversion, backdoor or otherwise, will be taxed based on the ratio of money in all traditional IRAs that was contributed on an after-tax basis to the total of all funds contributed on a pre-tax basis plus earnings on all traditional IRA money.
To illustrate how the pro-rata rule works, let’s continue with our example of a 40 year old making a $6,000 after-tax contribution to their traditional IRA with the intent of converting all of the contribution amount via a backdoor Roth IRA.
If their total traditional IRA balance is now $150,000, including $125,000 that is attributable to a combination of pre-tax contributions and earnings on the IRA account money, then the taxes on the $6,000 converted via the backdoor Roth method would be:
- $125,000 divided by $150,000 equals 80%
- Federal taxes would be due on 80% or $4,800 of the amount converted at the account holder’s ordinary income tax rate.
Should You Do a Backdoor Roth IRA?
If your income prohibits you from contributing to a Roth IRA or limits the amount you can contribute, there is no reason not to do a backdoor Roth IRA if your goal is to funnel more retirement money into a Roth account. There may be taxes on the amount converted, but those taxes will often be on less than 100% of the amount of the backdoor Roth IRA conversion.
In addition to a backdoor Roth IRA, there are other ways to fund a Roth account, depending upon your situation.
A Roth 401(k) option, if offered by your employer’s plan or via a Solo 401(k) if you are self-employed, allows contributions up to the annual employee contribution limit with no income restrictions. Contributions are made with after-tax dollars and can be rolled over to a Roth IRA account once you leave the employer if so desired. Some 403(b) and 457 plans offer Roth options as well.
Some employers offer a mega backdoor Roth option with their 401(k) plan. Under this scenario you make after-tax contributions to the company’s plan up to $40,500. This is over and above the limits for employee contributions which are $20,500 and $27,000 for those who are 50 or over.
Depending upon the plan, this money can be converted to a Roth 401(k) on an in-service basis if allowed, or it can be converted to a Roth IRA when you are eligible to take distributions. In the latter case you would take the distribution as a rollover to an IRA and do the Roth conversion as part of the rollover or after the money has been rolled over to the outside IRA custodian.
In deciding whether or not a backdoor Roth IRA is right for your situation, it makes sense to consult with a financial or tax advisor.