Back Door Roth IRA 

By Mike Cona on March 28, 2024

You’ve probably heard of a Roth IRA but have you ever heard of a back door Roth IRA? It sounds like something that could get you in trouble with the IRS, right? But it’s completely legal and many high-income earners use this strategy to contribute to Roth IRAs indirectly. 

Why is this important? Roth IRAs are an excellent long-term investment account because they offer tax-deferred growth and tax-free withdrawals in retirement. However, eligibility to make direct Roth IRA contributions can be restricted by income limits. In 2024, the adjusted gross income limit for single filers is $161,000, and for married couples filing jointly, it’s $240,000. 

Back door Roth IRAs allow investors to participate despite these limits. Here’s how it works, in three easy-to-follow steps: 

Step One: The Nondeductible Contribution 

First, you make a contribution to a Traditional IRA. The contribution limit for 2024 is $7,000, or $8,000 if you’re age 50 or older. Since in this case, we’re referring to higher-income earners, this IRA contribution would be after-tax, or non-deductible.  

Step Two: The Roth Conversion 

Next you’ll convert your Traditional IRA into your Roth IRA. We refer to this as a ‘Roth conversion’ and it’s perfectly allowable within the rules. 

Step Three: Ready to Invest! 

Finally, upon completion of the conversion, your contributed funds will now be in your Roth IRA and ready to invest and grow tax-deferred for retirement, even though your income was too high to contribute directly. 

Understanding When Roth Conversions are Taxable  

It’s very important to note that this technique works best when you don’t have any pre-tax IRA balances, because the IRS considers all IRA balances together when determining if a Roth conversion is taxable. However, even if you do have pre-tax IRA balances, it may still be beneficial to pay some tax on a conversion now because, after that, your Roth IRA money will grow tax deferred,and there will be no taxes due when you withdraw from it during retirement.  Generally speaking, the longer you have until you’ll need to access these funds in retirement, the more likely it could be in your interest to convert, even if you’lll owe income tax on a portion of the conversion.    

Summing Up… 

There you have it – the back door Roth IRA strategy in a nutshell. It’s an effective strategy for those who earn too much to contribute directly to a Roth IRA. 

As always, we encourage you to consult with your tax advisor when considering a back door Roth IRA to understand the rules, tax implications, and suitability for your specific situation. 

Are you wondering if a back door Roth IRA may make sense for you as part of your financial plan?  If so, please don’t hesitate to reach out to discuss.   

Source: “2023-2024 Roth IRA Contribution Limits.”. Charles Schwab, www.schwab.com/ira/roth-ira/contribution-limits. Accessed 26 Feb 2024.