Backdoor Roth IRAs: Are They Right for You?

If you’re saving for retirement, you’re likely already familiar with Roth IRAs: retirement accounts, funded with after-tax dollars, that grow tax-free and allow you to make tax-free withdrawals on qualified distributions in retirement.

While Roth IRAs are an excellent option to fund your retirement, they do come with a few challenges—particularly if you’re a high-income earner (as of 2024, defined as those with a modified adjusted gross income (MAGI) of $161,000+ for individuals and $240,000+ for married couples filing jointly). If you exceed these income thresholds, the IRS won’t allow you to make direct contributions to a Roth IRA.

Fortunately, high-income earners can explore an alternative solution—which is precisely where backdoor Roth IRAs come into play.

What is a backdoor Roth IRA?

A backdoor IRA isn’t a type of retirement account—it’s simply a strategy that allows higher-income investors to fund a Roth IRA even though their income exceeds IRS limits.

How does a backdoor Roth IRA work?

There are several ways to utilize a backdoor Roth IRA, each of which often requires converting a portion or all of traditional IRA funds to a Roth IRA. Let’s explore specifics on how to create a backdoor Roth IRA:

One approach is to contribute money to an existing traditional IRA and then roll over contributed funds into a Roth IRA account. Alternatively, you can roll over pre-existing traditional IRA funds—any amount you want, up to the entire balance—into a Roth IRA. A third option, meanwhile, is to roll over your 401(k) account into a Roth IRA. While the last approach is most common when changing jobs, it’s sometimes also prudent for existing employees as well (if allowed by one’s employer).

Regardless of the method you choose, keep in mind there are zero limits on Roth conversions: meaning you can convert as much money as you’d like.

What are some backdoor Roth IRA advantages?

So, just why is it so advantageous to take the extra steps required to create a backdoor Roth IRA? Several reasons in fact, starting with taxes. While you’ll pay taxes on converted funds (more on that shortly), everything thereafter is tax-free (assuming you make qualified distributions). This is an appealing feature for many people who believe their taxable income or tax rates will grow in the future.

Another backdoor Roth IRA advantage is that there’s no need to worry about required minimum distributions (RMDs), which are not relevant in this case. If you’re not already aware, RMDs are the minimum amount of money one must withdraw from specific tax-deferred retirement accounts beginning at age 73 (climbing to age 75 in 2033, for those turning 74 after December 31, 2032). As a result, you’ll enjoy tax-free growth on balances for the duration of your life.

What’s more, while any heirs must still adhere to IRA inheritance rules, you can pass on money in your Roth IRA tax-free: provided you’ve owned the account for at least five years.

What are some backdoor Roth IRA disadvantages?

While backdoor IRAs boast several benefits, this strategy also has some drawbacks.

For starters, you’ll still need to pay taxes on the amount of money you convert from a traditional IRA. You’ll also owe taxes on the money your traditional IRA earned between the time you contributed to it and the date you converted it to a Roth IRA. Consequently, this money may count as taxable income and kick you into a higher tax bracket.

You’ll also need to familiarize yourself with the pro-rata rule, which plays a large part in determining your taxes. Essentially, the IRS requires rollovers from traditional IRAs to Roth IRAs in a “pro-rata” fashion: meaning they will examine all of your IRA accounts—combined, not just the one used for the conversion—and tax you proportionally. The only exceptions in this case are inherited IRAs.

More specifically, if the cumulative amount of your IRAs consists of 60% pre-tax money and 40% after-tax money, this ratio determines which percentage converted to a Roth IRA is taxable; 60% of the amount converted to a Roth IRA applies in this case, regardless of how much money you choose to convert.

As for the purpose of the pro-rata rule, it seeks to prevent investors from avoiding taxes when converting after-tax IRA money to Roth IRAs.

Other backdoor Roth IRA considerations

Also keep in mind the five-year rule, a waiting period imposed on specific types of account withdrawals such as Roth IRAs. With respect to backdoor IRAs, you’re required to wait five years before withdrawing any converted balances (contributions or earnings)—regardless of your age. A failure to do so will result in a 10% penalty when you file your taxes.

It’s also important to know that this five-year period begins on January 1 of the year you convert your IRA. For example, if you convert your IRA in December 2024, your window actually would have begun on January 1, 2024.

What’s more, each conversion you make has its own distinct five-year period. For example, let’s assume you make one Roth conversion in 2024 and another in 2025. In this case, your five-year period would begin on January 1, 2024 for your 2024 conversion, and your 2025 conversion window would start on January 1, 2025.

When to avoid a backdoor Roth IRA

A backdoor Roth IRA doesn’t necessarily benefit everyone, especially those who require access to the converted funds during their five-year window or can meet their savings goals through other retirement accounts. Also shy away from a backdoor Roth conversion if you expect to enter a lower tax bracket after retirement.

In sum: how backdoor Roth IRAs can help you save more for retirement

As you can see, a backdoor Roth IRA is sometimes a valuable tax-planning tool for retirement preparations: especially among high-income earners. However, this strategy is also often very confusing. That’s why we recommend speaking with your financial advisor so he or she can help guide you based on your own unique situation.

FAQs

• Is a backdoor Roth IRA worth it?

  Given that income tax rates in America are the lowest they’ve been in years, a backdoor Roth IRA may make sense for many investors as taxes will likely increase after current rates sunset in 2026. However, the true answer to this question depends on your own unique financial situation; you should therefore consult with a financial advisor who can help you evaluate whether a backdoor Roth IRA makes sense for you.

• Will backdoor Roth IRAs eventually be eliminated?

  While it’s true that Congress has proposed placing limits on—or even eliminating—backdoor Roth conversions, legislative efforts have recently focused on helping Americans save for retirement rather than limiting conversions. As a result, any short-term pressure investors may have faced while seeking to take advantage of this strategy is gone for the time being.

• What is a mega back door Roth?

  This strategy provides a viable way for high earners to reap some benefits of traditional Roth IRAs that would otherwise be unavailable. More specifically, it allows individuals to contribute up to an additional $43,500 (for a total of $66,000, or $73,500 for individuals aged 50+) of after-tax dollars into a Roth IRA and/or Roth 401(k). However, not everyone can implement this strategy. Click on the link to read all about mega back door Roth IRAs.

• When are taxes triggered on my backdoor Roth IRA conversion?

  Conversions are taxed in the year in which they are processed, and you can contribute to an IRA for the prior year up until April 15th of the current one. Therefore, if you request a conversion on February 26th, taxes on the converted amount—if applicable—will be due when you file taxes for the following year. Note that you can elect to pay taxes at the time of the conversion, but it’s often prudent to hold off on doing so if you can.

• I’m going to make less money next year; should I wait to implement a backdoor Roth strategy?

  It may make sense for you to do this, but know that many investors decide to “chunk” their conversions by breaking up the conversions over time: avoiding a huge tax bill by spreading their tax burden out over a few years.

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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.

Disclosures:
This document is a summary only and not intended to provide specific advice or recommendations for any individual. 

All investing involves risk including loss of principal. Securities offered through LPL Financial, Member FINRA/SIPC.  Investment Advice offered through Vision Retirement, a registered investment advisor and separate entity from LPL Financial.