While most people can contribute directly to a Roth IRA, the IRS defines income limits that prevent high income earners from doing just that. Enter the backdoor Roth IRA—a colloquial term for the conversion of a traditional IRA to a Roth IRA which allows high income earners to indirectly fund a Roth individual retirement account.
We all know the awesome benefits of a Roth IRA: money grows tax free and you pay no taxes on it in retirement. It’s no wonder that high income earners are willing to jump through a few hoops to access Roth IRAs. A backdoor Roth IRA essentially allows people with high incomes to avoid Roth IRA contribution limits.
Here is a list of 5 essential backdoor Roth IRA facts that you should know about.
1. A Backdoor Roth IRA is Essentially a Rollover of a Traditional IRA
Simply put, a backdoor Roth IRA is the act of rolling over a traditional IRA to a Roth IRA. While just about anyone with a traditional IRA can execute a backdoor Roth IRA conversion, it makes the most sense for high income earners. You see, the IRS establishesRoth IRA contribution limitsbased on your salary. Those who make over a certain salary are not eligible to contribute directly to a Roth IRA; however, they can fund a Roth IRA using this backdoor method.
2. Roth IRA Contribution Limits Dictate The Need for a Backdoor Roth IRA
Single, head of household, or married filing separately not living with your spouse
Less than $122,000
$6,000
$122,000 to $137,000
Reduced amount*
$137,000 or more
$0
*useIRS Worksheet 2-2to determine your reduced Roth IRA contribution limit
Not everyone needs to fund their Roth IRA through the backdoor method. A backdoor Roth IRA is only necessary for high income earners according to the2019 Roth IRA Contribution Limitstable above. Anyone who has a Roth IRA contribution limit of $0 or a reduced amount can fund a Roth IRA via the backdoor method.
3. Immediately Rollover a Traditional IRA to Roth IRA to Avoid Taxes
In order to minimize taxes, it is recommended that you convert your traditional IRA to a Roth IRA as soon as possible after contributing. Whether you make periodic deposits into a traditional IRA throughout the year or one large lump sum contribution, the sooner you rollover from traditional to Roth, the better.
You must pay tax on any traditional IRA earnings when converting to a Roth IRA. Therefore, it makes sense to fund your Roth IRA through the backdoor method immediately after contributing to your traditional IRA. In other words, rollover your traditional IRA funds to a Roth IRA account right after making any contributions.
Theone-rollover-per-yearrule does not apply to rollovers from traditional IRAs to Roth IRAs meaning you can technically fund your backdoor Roth IRA multiple times per year. Although you have this freedom and flexibility, be sure to convert from traditional to Roth as soon as possible after funding your traditional IRA to avoid paying taxes on any gains.
4. You Have Until April 15, 2020 to Make a 2019 IRA Contribution
Contrary to popular belief, the IRA contribution deadline is April 15th of every year, not December 31st. This means you can make 2019 IRA contributions until April 15, 2020. In other words, you have a total of 15.5 months between January 1, 2019 and April 15, 2020 to contribute to your IRA accounts.
Because there is an extra step of rolling over funds and since you want to avoid paying taxes on gains, it is recommend that you fund your traditional IRA in a lump sum sometime before the April tax deadline and quickly convert theses funds into a Roth IRA via the backdoor method.
5. You Must Have Earned Income to Fund a Backdoor Roth IRA
If you don’t earn any income during the year, you are not eligible to contribute to an IRA. Earned income does not include:
Additionally, if your income is less than the Roth IRA contribution limit, you can only contribute as much as you earn. For example, the Roth IRA contribution limit in 2019 is $6,000. If you only earn $3,500 in 2019, you can contribute at most $3,500 to an IRA.
Although I don’t earn enough money (yet) to need a backdoor Roth IRA, I am still very much interested in this topic and the topic ofretirement savings and investingin general. Do you have a backdoor Roth IRA or planning on contributing to one? I’d love to hear from you in the comments below.
Accessed Apr 8, 2022. You'll need the money in five years or less. Money converted from an IRA to a Roth IRA falls under a Roth five-year rule: If you don't wait five years to withdraw it, you could owe taxes and a 10% penalty. The withdrawal from your IRA will push you into a higher income tax bracket.
Right now, the mega backdoor Roth is not going away as long as your employer plan allows it. That's good news! But it's not permanent news – there could be legislation on the way that eliminates the option to make after-tax contributions.
Cons: All or part of a backdoor Roth IRA conversion could be a taxable event. You may have to pay federal, state, and local taxes on converted earnings and deductible contributions. Conversions could kick you into a higher tax bracket for the year.
The Roth IRA five-year rule says you cannot withdraw earnings tax-free until it's been at least five years since you first contributed to a Roth IRA account. This five-year rule applies to everyone who contributes to a Roth IRA, whether they're 59 ½ or 105 years old.
You may not need a backdoor Roth conversion if you are able to meet your savings goals with the maximum retirement limit through your workplace retirement account, and are not expecting a need for additional savings.
One can reduce or even eliminate pre-tax IRA funds, therefore avoiding the pro-rata rule. Bypassing the pro-rata rule on the Roth conversion portion of the backdoor Roth strategy requires the account owner to have $0 of pre-tax money in all non-Roth IRAs at the end of the year of the conversion (i.e., December 31).
Yes, even though the Build Back Better Act in 2004 was drawn up to end backdoor Roth IRAs by 2020, this financial strategy remains in place for now. It is unknown, however, whether any future legislation will remove the backdoor Roth.
You won't pay double taxes with a backdoor Roth, but you may end up paying some taxes depending on your financial situation. Talk with your financial advisor before making this move to minimize taxes and maximize retirement benefits.
Whether it is worth it to do a backdoor Roth IRA depends on your financial situation. If, for example, you are in the 22% federal marginal income tax bracket (or under), you should do a Roth IRA to diversify your retirement funds. If your federal income tax bracket reaches 24%, you are at a neutral state, more or less.
A backdoor Roth is a loophole that avoids income limits to be eligible to contribute to a tax-free Roth IRA retirement account. The loophole: Taxpayers making more than the $161,000 limit in 2024 can't contribute to a Roth IRA, but they can convert other forms of IRA accounts into Roth IRA accounts.
The tax requirements for a backdoor Roth IRA involve reporting nondeductible contributions to a traditional IRA and subsequent conversions to a Roth IRA on Form 8606. Failing to do so, could cost you more money in IRS penalties and additional taxes on the converted amount.
The 5-year rule regarding Roth IRAs requires a waiting period before you can withdraw earnings or convert funds without a penalty. To withdraw earnings from a Roth IRA without owing taxes or penalties, you must have held the account for at least five tax years.
Even when you're close to retirement or already in retirement, opening this special retirement savings vehicle can still make sense under some circ*mstances. There is no age limit to open a Roth IRA, but there are income and contribution limits that investors should be aware of before funding one.
“If you open a Roth IRA for the first time in order to receive Roth 401(k) rollover funds, then you must wait five years to take a distribution penalty-free.” This rule wouldn't prevent you from withdrawing your original contributions after the rollover is complete.
For this rule, the five-year period begins the first day of the tax year in which you converted money from a traditional IRA (or did a rollover from a qualified retirement plan) to your Roth IRA. For example, if you do a conversion on May 1, 2024, the rule for that conversion actually begins on January 1, 2024.
The Internal Revenue Service (IRS) requires a waiting period of 5 years before withdrawing balances converted from a traditional IRA to a Roth IRA, or you may pay a 10% early withdrawal penalty on the conversion amount in addition to the income taxes you pay in the tax year of your conversion.
The limits are as follows: For 2023: Between $138,000 and $153,000 for single filers and between $218,000 and $228,000 for joint filers. For 2024: Between $146,000 and $161,000 for single filers and between $230,000 and $240,000 for married couples filing jointly4.
Introduction: My name is Rev. Leonie Wyman, I am a colorful, tasty, splendid, fair, witty, gorgeous, splendid person who loves writing and wants to share my knowledge and understanding with you.
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