Backdoor Roth IRA

A two-step workaround for high earners: contribute after-tax money to a traditional IRA, then convert it to a Roth IRA.

What it means

People whose income is too high to contribute to a Roth IRA directly can still get money into one. They make a nondeductible contribution to a traditional IRA, then convert it to a Roth IRA, usually soon after so little growth is taxed. Because the contribution was already taxed, the conversion of that amount is not taxed again.

The catch is the pro-rata rule. When converting, the IRS treats all pre-tax money in traditional, SEP and SIMPLE IRAs as one pool, measured at year-end, so the conversion is taxed in proportion to the pre-tax share. Moving pre-tax IRA money into an employer plan, if the plan accepts it, can avoid this. Form 8606 tracks the after-tax basis.

Example

Suppose someone makes a $5,000 nondeductible IRA contribution but also has $45,000 of pre-tax money in a rollover IRA. Only 10% of their $50,000 total is after-tax, so converting $5,000 makes $4,500 taxable.

How it’s used

High earners above the Roth income limits
Adding to tax-free savings each year
Workers with no pre-tax IRA balances

Strengths and weaknesses

Strengths

Opens Roth savings regardless of income
Little or no tax when there are no pre-tax IRA balances
Can be repeated each year

Weaknesses

Pro-rata rule can make much of the conversion taxable
Extra paperwork and reporting
Still capped by the annual IRA contribution limit

Good to know

Checking all IRA balances, including SEP and SIMPLE accounts, before converting avoids a surprise tax bill.

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.