Backdoor Roth IRA

Overview

A backdoor Roth IRA is a legal strategy that enables high-income taxpayers—who are otherwise ineligible for direct Roth IRA contributions—to move after-tax money into a Roth IRA. It uses a nondeductible contribution to a traditional IRA followed by a conversion to a Roth IRA. The result, when done correctly, is tax-free growth and tax-free qualified withdrawals from the Roth.

Who it’s for

This strategy is useful for earners whose modified adjusted gross income (MAGI) exceeds the IRS thresholds for direct Roth IRA contributions but who still want Roth-style tax treatment. It’s also an option for people who’ve already maxed out employer Roth accounts and want additional Roth savings.

Contribution limits (example)

For recent tax years the annual contribution limit for IRAs has been:
* $7,000 for most taxpayers (plus a $1,000 catch-up if age 50 or older).

Always check current IRS limits before contributing.

How it works — step by step

1. Open a traditional IRA at a brokerage or custodian.
2. Make a nondeductible (post-tax) contribution to that traditional IRA, up to the annual IRA limit and limited by earned income.
3. Convert the contributed funds from the traditional IRA to a Roth IRA. Convert as soon as practical to minimize earnings in the traditional IRA (any earnings before conversion are taxable).
4. Report the nondeductible contribution and conversion on IRS Form 8606 when you file taxes to document that the contribution was after-tax.

You can perform a backdoor Roth each year. Complete these steps before the tax filing deadline if you intend the contribution to apply to a prior tax year.

Tax implications and Form 8606

• The nondeductible contribution itself does not generate a tax deduction.
• If you convert right away and there are no earnings, the conversion should not trigger additional income tax on the contributed amount. Any pre-conversion earnings are taxable at ordinary income tax rates.
• File Form 8606 to report nondeductible contributions and conversions; otherwise the IRS may treat the conversion as taxable.

Brokerage firms will issue Form 1099-R (reporting the conversion/distribution) and Form 5498 (reporting IRA contributions). Form 8606 reconciles these items on your tax return.

The pro‑rata rule (important caveat)

If you own other traditional, SEP, or SIMPLE IRAs (including rollovers from 401(k)s) that contain pre-tax balances, the IRS treats all non-Roth IRAs as a single combined account for taxation of conversions. The taxable portion of any conversion is determined on a pro‑rata basis.

Example:
* Pre-tax balance in existing traditional IRA: $15,000
New nondeductible contribution: $5,000
Combined IRA balance: $20,000
Pre-tax share: 15,000 / 20,000 = 75%
Taxable portion of the $5,000 conversion = 75% × $5,000 = $3,750 (taxed at your ordinary rate)

Because of the pro‑rata rule, many taxpayers with existing pre-tax IRA assets face unexpected tax bills when they attempt a backdoor Roth.

Advantages

• Gives high‑income earners access to Roth tax benefits (tax-free growth and tax-free qualified withdrawals).
• Contributions (and earnings, if qualified) are not subject to income tax in retirement.
• Anyone with earned income (or a spouse with earned income) can use the technique, regardless of employer retirement plan offerings.

Disadvantages and risks

• Can trigger taxes under the pro‑rata rule if you have pre-tax IRA balances.
• Small timing or reporting mistakes can create taxable events that are not easily reversed.
• Administrative burden and a need to file Form 8606 correctly each year.
• Some advisors recommend waiting a short interval between contribution and conversion for recordkeeping, which can increase the chance of taxable earnings.

Alternatives

• Roth 401(k): Many employers offer Roth 401(k) contributions with no MAGI limit—contributions are subject to 401(k) limits and employer plan rules.
• Mega‑backdoor Roth: Uses after-tax contributions inside a 401(k) with in-plan Roth conversion or in-service distribution options to move larger sums into Roth. Requires a qualified employer plan.

When to avoid a backdoor Roth

• If you are eligible to contribute directly to a Roth IRA (no need to complicate things).
• If you have existing pre-tax IRA balances and cannot avoid the pro‑rata tax consequences—consult a tax professional.
• If you’re unsure about properly reporting the transaction on your tax return.

Practical tips

• Convert promptly after the nondeductible contribution to minimize taxable earnings.
• Keep clear records and ensure Form 8606 is filed every year you use this strategy.
• If you have pre-tax IRA funds and want to avoid the pro‑rata rule, consider rolling pre-tax IRA balances into a current employer plan (if allowed) before doing conversions, but check plan rules and tax consequences first.
• Consult a CPA or tax advisor if you have complex IRA or rollover histories.

Key takeaways

• A backdoor Roth IRA is a legal method for high earners to fund a Roth IRA via a nondeductible traditional IRA contribution followed by conversion.
• The biggest tax pitfall is the pro‑rata rule, which can make part of the conversion taxable if you have other pre-tax IRAs.
• Proper timing, accurate reporting (Form 8606), and consultation with a tax advisor can help avoid unintended tax costs.