Want to contribute to a Roth IRA, but have an income that exceeds the limits? There’s another option. It’s called a backdoor Roth IRA, and it’s a way of converting funds from a traditional IRA to a Roth.
A Roth IRA is an individual retirement account that may provide investors with a tax-free income once they reach retirement. With a Roth IRA, investors save after-tax dollars, and their money generally grows tax-free. Roth IRAs also provide additional flexibility for withdrawals — once the account has been open for five years, contributions can generally be withdrawn without penalty.
But there’s a catch: Investors can only contribute to a Roth IRA if their income falls below a specific limit. If your income is too high for a Roth, you may want to consider a backdoor Roth IRA.
Key Points
• A backdoor Roth IRA allows high earners to contribute to a Roth IRA by converting funds from a traditional IRA.
• This strategy involves paying income taxes on pre-tax contributions and earnings at conversion.
• There are no income limits or caps on the amount that can be converted to a Roth IRA.
• The process includes opening a traditional IRA, making non-deductible contributions, and then converting these to a Roth IRA.
• Potential tax implications include moving into a higher tax bracket and owing taxes on pre-tax contributions and earnings.
What Is a Backdoor Roth IRA?
If you aren’t eligible to contribute to a Roth IRA outright because you make too much, you can do so through a technique called a “backdoor Roth IRA.” This strategy involves contributing money to a traditional IRA and then converting it to a Roth IRA.
The government allows individuals to do this as long as, when they convert the account, they pay income tax on any contributions they previously deducted and any profits made. Unlike a standard Roth IRA, there is no income limit for doing the Roth conversion, nor is there a ceiling to how much can be converted.
💡 Quick Tip: How much does it cost to open an IRA account? Often there are no fees to open an IRA, but you typically pay investment costs for the securities in your portfolio.
How Does a Backdoor IRA Work?
This is how a backdoor IRA typically works: An individual opens a traditional IRA and makes non-deductible contributions. They then convert the account into a Roth IRA. The strategy is generally most helpful to those who earn a higher salary and are otherwise ineligible to contribute to a Roth IRA.
Example Scenario
For instance, let’s say a 34-year-old individual wants to open a Roth IRA. Their tax-filing status is single and they earn $165,000 per year. Their income is too high for them to be eligible for a Roth directly (more on this below), but they can use the “backdoor IRA” strategy. In order to do this, the individual would open a traditional IRA and contribute non-deductible funds to it. They then convert that money to a Roth IRA.
Recommended: Traditional Roth vs. Roth IRA: How to Choose the Right Plan
Income and Contribution Limits
In general, Roth IRAs have income limits. In 2024, a single person whose modified adjusted gross income (MAGI) is $161,000 or more, or a married couple filing jointly with a MAGI that is $240,000 or more, cannot contribute to a Roth IRA. For tax year 2025, a single filer whose MAGI is $165,000 or more, or a married couple filing jointly with a MAGI that is $246,000 or more, cannot contribute to a Roth IRA.
There are also annual contribution limits for Roth IRAs. For tax years 2024 and 2025, the annual contribution limit for traditional and Roth IRAs is $7,000. These IRAs allow for a catch-up contribution of up to $1,000 per year if you’re 50 or older. Traditional IRAs have the same contribution limits as Roth IRAs.
How to Set Up and Execute a Backdoor Roth
Here’s how to initiate and complete a backdoor Roth IRA.
• Open a Traditional IRA. You could do this with SoFi Invest®, for instance.
• Make a non-deductible contribution to the Traditional IRA.
• Open a Roth IRA, complete any paperwork that may be required for the conversion, and transfer the money into the Roth IRA.
Tax Impact of a Backdoor Roth
If you made non-deductible contributions to a traditional IRA that you then converted to a Roth IRA, you won’t owe taxes on the money because you’ve already paid taxes on it. However, if you made deductible contributions, you will need to pay taxes on the funds.
In addition, if some time elapsed between contributing to the traditional IRA and converting the money to a Roth IRA, and the contribution earned a profit, you will owe taxes on those earnings.
You might also owe state taxes on a Roth IRA conversion. Be sure to check the tax rules in your area.
Another thing to be aware of: A conversion can also move people into a higher tax bracket, so individuals may consider waiting to do a conversion when their income is lower than usual.
And finally, if an investor already has traditional IRAs, it may create a situation where the tax consequences outweigh the benefits. If an individual has money deducted in any IRA account, including SEP or SIMPLE IRAs, the government will assume a Roth conversion represents a portion or ratio of all the balances. For example, say the individual contributed $5,000 to an IRA that didn’t deduct and another $5,000 to an account that did deduct. If they converted $5,000 to a Roth IRA, the government would consider half of that conversion, or $2,500, taxable.
The tax rules involved with converting an IRA can be complicated. You may want to consult a tax professional.
💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.
Is a Backdoor Roth Right for Me?
It depends on your situation. Below are some of the benefits and downsides to a backdoor Roth IRA to help you determine if this strategy might be a good option for you.
Benefits
High earners who don’t qualify to contribute under current Roth IRA rules may opt for a backdoor Roth IRA.
As with a typical Roth IRA, a backdoor Roth may also be a good option when an investor expects their taxes to be lower now than in retirement. Investors who hope to avoid required minimum distributions (RMDs) when they reach age 73 might also consider doing a backdoor Roth.
Downsides
If an individual is eligible to contribute to a Roth IRA, it won’t make sense for them to do a backdoor conversion.
And because a conversion can also move people into a higher tax bracket, you may consider waiting to do a conversion in a year when your income is lower than usual.
For those individuals who already have traditional IRAs, the tax consequences of a backdoor Roth IRA might outweigh the benefits.
Finally, if you plan to use the converted funds within five years, a backdoor Roth may not be the best option. That’s because withdrawals before five years are subject to income tax and a 10% penalty.
Is a Backdoor Roth Still Allowed in 2024 or 2025?
Backdoor Roth conversions are still allowed for tax years 2024 and 2025.
There had been some discussion in previous years of possibly eliminating the backdoor Roth strategy, but this has not happened as yet.
The Takeaway
A backdoor Roth IRA may be worth considering if tax-free income during retirement is part of an investor’s financial plan, and the individual earns too much to contribute directly to a Roth.
In general, Roth IRAs may be a good option for younger investors who have low tax rates and people with a high income looking to reduce tax bills in retirement.
Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
What are the rules of a backdoor Roth IRA?
The rules of a backdoor Roth IRA include paying taxes on any deductible contributions you make; paying any other taxes you may owe for the conversion, such as state taxes; and waiting five years before withdrawing any earnings from the Roth IRA to avoid paying a penalty.
Is it worth it to do a backdoor Roth IRA?
It depends on your specific situation. A backdoor Roth IRA may be beneficial if you earn too much to contribute to a Roth IRA. It may also be advantageous for those who expect to be in a higher tax bracket in retirement.
What is the 5-year rule for backdoor Roth IRA?
According to the 5-year rule, if you withdraw money from a Roth IRA before the account has been open for at least five years, you are typically subject to a 10% tax on those funds. The five year period begins in the tax year in which you made the backdoor Roth conversion. There are some possible exceptions to this rule, however, including being 59 ½ or older or disabled.
Do you get taxed twice on backdoor Roth?
No. You pay taxes once on a backdoor IRA — when you convert a traditional IRA with deductible contributions and any earnings to a Roth. When you withdraw money from your Roth in retirement, the withdrawals are tax-free because you’ve already paid the taxes.
Can you avoid taxes on a Roth backdoor?
There is no way to avoid paying taxes on a Roth backdoor. However, you may be able to reduce the amount of tax you owe by doing the conversion in a year in which your income is lower.
Can you convert more than $6,000 in a backdoor Roth?
There is no limit to the amount you can convert in a backdoor Roth IRA. The annual contribution limits for IRAs does not apply to conversions. But you may want to split your conversions over several years to help reduce your tax liability.
What time of year should you do a backdoor Roth?
There is no time limit on when you can do a backdoor Roth IRA. However, if you do a backdoor Roth earlier in the year, it could give you more time to come up with any money you need to pay in taxes.
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