A Roth IRA is an individual retirement account that allows you to set aside after-tax income up to a specified amount each year. Both earnings on the account and withdrawals after age 59 1/2 are tax free if it has been at least five years since you first opened and contributed to your Roth IRA, regardless of your age when you opened it.

Many of our clients would like to make Roth IRA contributions, but their income exceeds the applicable income limits. If you earn too much money (see chart below) you cannot open Roth IRAs under current IRS rules.

This puts one of the best features of a Roth IRA out of reach: the ability to maximize tax-free growth even after age 73 because Roth IRAs do not require minimum distributions (RMDs). So, if you don’t need income from your Roth IRA, your balance continues to grow tax-free until it passes to your heirs.

Enter the Backdoor Roth, an option for those who earn more income than the current limits to establish a Roth IRA. With a Backdoor Roth, you first contribute to a Traditional IRA and then convert it to a Roth IRA.

First Let’s Take a Look at the Roth IRA Limits for 2024

What Then is a “Backdoor Roth”?

A Backdoor Roth is a conversion of Traditional IRA assets to a Roth IRA. Currently, anyone can convert money that they have put into a Traditional IRA to a Roth IRA, no matter how much income they earn. You can also roll as much money as you want from a Traditional IRA into a Roth IRA, exceeding the contribution limits on IRAs. Therefore, investors can contribute through the backdoor by making a nondeductible traditional IRA contribution and then converting to a Roth IRA. This allows you to avoid both Roth IRA income limits and Roth IRA contribution limits.

Example: Ned would like to make a Roth IRA contribution, but he is above his applicable income limit, so he is utilizing the Backdoor Roth IRA strategy. If Ned contributes $6,000 to his traditional IRA, he will have no deduction and his contribution will go in as after-tax funds. A month later, when his IRA account has risen to $6,200, Ned converts his traditional IRA to a Roth IRA. Since $6,000 of the $6,200 converted consists of after-tax dollars, only the $200 of gain will be taxable upon conversion. Thus, Ned will have paid tax on a total of $6,200, the entire balance of his Roth IRA at that point.

Tax Considerations

Looking at it from a tax standpoint, this strategy works best if you don’t have other traditional, deductible IRA assets, because if you do, part of the conversion would be subject to income tax.

Example: Jan has $114,000 in her traditional IRA, all of which is pre-tax. If Jan makes a $6,000 nondeductible (after-tax) contribution to a traditional IRA, the total IRA balance will be $120,000, $6,000 of which will be after-tax. Thus, only 5% ($6,000 / $120,000 = 5%) of her Roth IRA conversion will be tax-free. If Jan converts $6,000 from her traditional IRA to a Roth IRA after making her nondeductible contribution, just $300 would be tax free ($6,000 x 5%), while the remaining $5,700 ($6,000 – $300 = $5,700) would be taxable upon conversion.