How to Fund a Roth IRA Even If Your Income is Too High (aka “Backdoor” Roth IRA strategy)

The Roth IRA is one of the best retirement investment vehicles ever invented. It provides tax-free growth and tax-free withdraws in retirement (after age 59 1/2) for any reason at all. In addition, you can withdraw your original contributions (i.e. your “principal”) tax and penalty free at any time, which is unique to Roth IRAs. The numbers can be quite extraordinary when you combine stock market returns plus consistent contributions. If all you did was contribute to a Roth IRA for 40 years, you would have over $3.6 million dollars in your account tax-free! (Read more about the kinds of stock market returns you can get over time.)

That alone is plenty to set you up for a comfortable retirement!

Funding a Roth IRA Difficult for High-Income Earners

However, getting money into a Roth IRA has always been the challenge. While those with low to moderately high incomes can contribute to a Roth as long as their income (technically “MAGI,” or modified adjusted gross income) is below $118,000 (if filing single, or $186,000 if filing jointly), those in higher income brackets have to be more creative. In that case, you can utilize a technique nicknamed “the backdoor Roth IRA.”

The “Backdoor Roth IRA contribution” is when someone with income above the limits makes a non-deductible IRA contribution to a traditional IRA account. (Not sure whether you should contribute to an IRA or a Roth IRA? Read more on that here.) Most of the time, I don’t recommend non-deductible IRA contributions, because without the tax deduction an IRA can only provide tax-deferral, and it’s debatable whether tax-deferral alone is enough to overcome the difference between ordinary income tax (on IRA withdraws) and capital gains rates (paid on gains inside a regular taxable brokerage account). This is because capital gains rates are currently much lower than income tax rates. 

The “Backdoor” Way to Fund a Roth IRA

However, in the special case where someone has ONLY non-deductible contributions in his or her IRA, AND no growth on the original contributions, he/she can convert that IRA into a Roth without any tax consequences. In that case, the two-step non-deductible IRA contribution PLUS Roth IRA conversion accomplishes exactly the same task as a normal Roth IRA contribution.

How to do a Backdoor Roth IRA:

  • Step One: Fund a traditional IRA account with after-tax dollars (non-deductible). This means you will not get a tax deduction on your tax return, but will instead record the IRA contribution as an “after-tax” contribution on Form 8606.
  • Step Two: Convert your traditional IRA contribution to a Roth IRA. Your financial institution will issue you a 1099-R at the end of the year. On it, they will report that you did a Roth IRA conversion, which is normally a taxable contribution. However, in this case, you already paid taxes on that money, so you don’t have to do so again. Talk to your tax preparer about how to record this on your tax return.

So, that’s why it’s called a “Backdoor Roth IRA strategy,” because it accomplishes the same goal (getting money into a Roth IRA) by using an alternative means. Almost anyone can now fund their Roth IRA due to the backdoor Roth approach.

An Important Warning

If you already have a regular IRA with pre-tax contributions (either because you contributed in the past and got a deduction or you rolled over money from a previous employer plan), any Roth IRA conversion will include pro-rata your pre-tax contributions and after-tax non-deductible contributions. What this means is that the “backdoor Roth” contribution strategy won’t work for you, because you’ll just be doing a normal Roth IRA conversion in that scenario. For those in an already high-income tax bracket (who would naturally be the ones interested in the backdoor Roth), that’s probably an unattractive proposition.

For more information: IRS Publication 590a – Roth IRAs

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