*Updated for 2024

You might have heard of a Roth IRA—a magical little retirement account packed with perks. But have you heard of a “backdoor Roth”? 

It sounds a tad sneaky, right? Like a secret knock to gain entry to an exclusive club. In many ways, it is, but in the best possible way. Let’s dive into this fairly unheard-of strategy to boost your retirement savings.

What is a Roth IRA?

To appreciate the appeal of the backdoor Roth IRA, we first need to understand the Roth IRA. 

A Roth IRA is a unique retirement account where you contribute after-tax dollars, meaning you’ve already paid taxes on the money you put in and don’t deduct the contributions on your taxes. The brilliance of the Roth is that as it grows—thanks to interest, dividends, and capital gains—you won’t owe income taxes on those earnings. You also don’t pay taxes on withdrawals in retirement. That’s right—100% tax-free growth and withdrawals.

This is different from a Traditional IRA, where you can deduct your contributions now but pay tax when you withdraw the funds in retirement. 

You still with us? Great! 

Other benefits of a Roth IRA include: 

• No required minimum distributions (RMDs). Unlike Traditional IRAs, with Roths, there’s no requirement to start withdrawing at a certain age.
• Flexibility. You can withdraw your contributions (but not earnings) any time without penalties.

For the 2024 tax year, you can contribute up to $7,000 to a Roth IRA ($8,000 if you’re 50 or older).

What is a backdoor Roth?

With all the benefits of a Roth IRA, of course there is a catch: income limits. High earners might find their ability to contribute limited or eliminated, staring wistfully at the Roth party from the outside.

The following table shows the Roth income limits based on your modified adjusted gross income (MAGI).

If your filing status is:	And your MAGI is:	Then you can contribute:
Married filing jointly or qualifying widow(er)	< $230,000	Up to the annual limit
	≥ $230,000 but < $240,000	A reduced amount
	≥ $240,000	Zero
Married filing separately and you lived with your spouse at any time during the year	< $10,000	A reduced amount
	≥ $10,000	Zero
Single, head of household, or married filing separately and you did not live with your spouse at any time during the year	< $146,000	Up to the annual limit
	≥ $146,000 but < $161,000	A reduced amount
	≥ $161,000	Zero

This is where the backdoor Roth IRA comes in. It’s a strategy, not a different type of account. If your income is too high to contribute directly to a Roth, the backdoor Roth allows you to skirt around these restrictions.

We know it sounds silly, but what makes it possible is that rather than contribute directly to a Roth IRA, you contribute to a traditional IRA and then convert it to a Roth. Yes, that’s it.

While you can convert an existing traditional IRA or 401(k) funds to a Roth anytime, you typically have to pay taxes on the conversion. With a backdoor Roth, you make the contribution and convert it immediately—perhaps even on the same day. This quick turnaround minimizes the earnings and tax implications.

Why use the backdoor Roth IRA?

The main benefit of a backdoor Roth is the ability to bypass income limits. If you’re a high earner and directly contributing to a Roth is off the table, the backdoor strategy is your ticket in. 

The other primary benefit is future tax diversification. If you believe tax rates might be higher when you retire, having tax-free income in retirement is pretty attractive.

Backdoor Roth limitations: The pro-rata rule

There is another catch: the pro-rata rule. You didn’t think it was going to be that easy, now did you? 

The pro-rata rule comes into effect if you have other Traditional IRAs, SEP IRAs, and/or rollover IRAs with deductible contributions. The IRS requires you to consider these when converting to Roth which could lead to a bigger tax bill. Instead of being able to convert 100% of your IRA balance, tax-free, you will have to claim a pro-rata figure as a taxable conversion. 

To sidestep this, some folks roll their existing IRAs (Traditional IRAs, SEP IRAs and/or rollover IRAs) into employer-sponsored plans, like a 401(k), which aren’t subject to the pro-rata rule before making backdoor Roth contributions.

So while the act of doing the backdoor Roth is simple (it’s just a transfer) if you’re over the income limits, you might need some pre-planning to get the intended results. On the other hand, people under the income limits can simply contribute directly to a Roth IRA without needing to worry about having funds in other IRA accounts. There are simply more potential hoops to jump through with a backdoor Roth conversion.

How to execute the backdoor Roth IRA strategy

Performing a backdoor Roth conversion is pretty simple. 

1. Start with a Traditional IRA. Contribute up to the annual limit to a traditional IRA. You should contribute to a traditional IRA with no balance for this strategy to work. Otherwise, part of your conversion could be taxable. (See the Pro-Rata rule above!)
2. Convert to a Roth IRA. After contributing, roll the funds in your traditional IRA account into a Roth IRA. When you log into your account online, it’s often as easy as clicking a button that says “Convert to Roth IRA.”
3. Pay the piper (if needed). If you had earnings or deductible contributions in your Traditional IRA before the conversion, you’ll owe taxes on those when you file your tax return. But if it’s a new Traditional IRA with only non-deductible contributions, there’s typically no tax bill for the conversion.

If your employer’s 401(k) plan allows it, you can do a “mega backdoor Roth IRA conversion” in the plan. Some 401(k) plans allow automatic Roth conversions. This means you make after-tax contributions to the plan and have them automatically converted to a Roth within your account. Check with your plan administrator to see if this option is available. Just keep in mind that Roth 401(k)s are subject to RMDs but still grow tax-free.

Tips to ace the backdoor Roth and minimize taxes

Before jumping into a backdoor Roth strategy, there are a few potential pitfalls to be aware of.

Be aware of the Roth IRA 5-year rule

Yep, more rules! While the Roth IRA boasts of tax-free withdrawals, it does come with a stipulation known as the ‘5-Year Rule.’ 

This rule mandates that for a withdrawal to be truly tax-free, the Roth IRA must have been open for at least five years since the initial contribution, even if you’ve reached the age of 59½. 

When you convert funds from a Traditional IRA to a Roth (like in the backdoor Roth strategy), each conversion has its own 5-year clock before you can withdraw earnings penalty-free, regardless of your age. 

So before making a conversion, ensure you won’t need the money for at least five years and keep track of those timelines to ensure you reap the full benefits of your Roth without unexpected tax implications.

Make timely transitions

Convert your Traditional IRA to a Roth as soon as possible to minimize any taxable earnings in the account.

Stay informed

While a backdoor Roth IRA conversion might seem like a shady move, it’s entirely legal (for now). However, some critics of this tax strategy believe it violates the “step-transaction doctrine,” which treats a series of separate transactions as a single transaction for tax purposes.

Taxpayers have been using the backdoor Roth for decades, and the IRS hasn’t officially provided guidance on whether it violates the step transaction doctrine. Congress has considered limiting backdoor Roth conversions in the past but hasn’t passed legislation to do so. Still, if you want to make annual backdoor Roth conversions part of your retirement savings strategy, working with an advisor who follows IRS guidance and is current on the rules is a good idea.

The backdoor Roth IRA is like a secret handshake in the world of retirement savings, allowing those who know about it to enjoy the benefits of a Roth IRA, even when direct contributions are off the table. While the strategy involves a few steps, you can navigate this savings route smoothly and efficiently with the right knowledge (and perhaps some sage advice from a tax professional).

Still unsure? Countless can help

Remember, the end game is a comfortable, enjoyable retirement. The backdoor Roth IRA is just one of many tools to get you there. And if you’re sitting there, still scratching your head, don’t worry. This stuff can be incredibly complicated.That’s why, here at Countless, we specialize in helping you identify tax strategies that maximize your hard-earned savings. Want our help? Reach out here.