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What Is a Backdoor Roth IRA - USMR

What Is a Backdoor Roth IRA? Benefits, Conversion Limits, and Rules

Brad Chastain Director of Education U.S. Money Reserve

Written by Brad Chastain

Nov 24, 2023

Most people have heard of an IRA, or individual retirement account. However, many people are surprised by the number of types of IRAs that exist, as well as the number of strategies they can utilize to maximize their retirement savings. One such retirement savings strategy is known as a “backdoor Roth IRA.”

A backdoor Roth IRA may be a beneficial financial move when done correctly. However, if this strategy isn’t set up and timed properly, it could end up costing you money rather than increasing your retirement savings. Read on to discover more about backdoor Roth IRAs and how you may be able to use this option to get even more out of individual retirement accounts.

What Is a Backdoor Roth IRA?

A backdoor Roth IRA is a financial strategy in which a person moves funds from their traditional IRA to a Roth IRA. It’s a different process than traditional Roth IRA conversions involving tax-deductible funds.

Why does the backdoor Roth IRA strategy exist? Because not everyone can contribute directly to a Roth IRA. The strategy is often used by high earners with annual incomes that exceed the limit for eligibility in making Roth IRA contributions.

Benefits of a Backdoor Roth IRA

For some, a backdoor Roth IRA conversion is the only way to put funds into a Roth IRA account. Roth IRAs have several advantages, especially for those doing long-term retirement planning. The money in a Roth IRA grows tax-free, and withdrawals in retirement are tax-free as well. That alone is enough reason for some people to consider a backdoor Roth IRA, especially if their taxes or income are likely to increase.

Also, unlike traditional IRAs, Roth IRAs don’t have required minimum distributions. This makes retirement planning more flexible. Another long-term estate planning advantage of Roth IRAs is that they can be assumed by the owner’s spouse, with the funds rolling over into a Roth IRA in the spouse’s name. Distributions could then be tax-free if the assets were held in the original Roth IRA for at least five years.

Backdoor Roth IRA Limit on Conversions

One aspect all IRAs share is contribution limits, which are dictated partly by income. For example, in 2023, you can’t directly contribute to a Roth IRA at all if you file as single on your taxes and earn $153,000 or more. If you file taxes as married filing jointly, the cut off for direct contributions is $228,000.

According to Fidelity, even if you make less than these thresholds, you may face additional contribution limitations. Single filers with income between $138,000 and $153,000 and those married filing jointly who make between $218,000 and $228,000 have a reduced contribution limit.

However, there is no backdoor Roth IRA limit. You can roll over as much as you’d like from a traditional IRA to a Roth IRA. Just keep in mind that the amount rolled over will be considered income for that tax year and is therefore taxable in many areas.

A Backdoor Roth IRA Conversion May Come With Taxes

Here’s the downside to backdoor Roth IRA rollovers: It’s taxable in many places. The converted funds could be subject to federal, state, and/or local taxes.

Backdoor Roth IRA taxes can be imposed at the state level. Currently, all but 13 states impose taxes on IRA plans. In the 37 states that tax retirement income, pensions and 401(k)s are also subject to income taxes.

Something else you may wish to consider is that using a backdoor Roth IRA could push you into a higher tax bracket. Once the conversion is complete, the amount converted is considered part of that year’s income. Without proper timing, a backdoor Roth IRA may cost more than expected.

There are additional rules that could lead to further taxes on the amount moved from a traditional IRA into a Roth IRA.

5-Year Rule for Backdoor Roth IRAs

There are rules for making contributions and taking distributions from an IRA. One of them is called the five-year aging rule. With Roth IRAs, direct contributions can be distributed tax-free at any time so long as the account holder is 59½ or older. But when completing a backdoor Roth IRA, funds must be held at least five years before being distributed to avoid penalty, and each conversion has its own five-year timeline. If you take a distribution before the five-year mark, you will likely have to pay a 10% penalty tax on the amount withdrawn.

If you’re nearing retirement and need to access the funds, you may wish to carefully consider the implications of the five-year aging rule before completing a backdoor Roth IRA. However, if you’re five or more years out from retirement and don’t plan to use the converted funds anytime soon, the five-year aging rule may be less of a concern.

What Is the Pro-Rata Rule for Roth Conversions?

Another rule that may be worth considering before completing a backdoor Roth IRA rollover is the pro-rata rule. This rule applies when a traditional IRA has a mix of pre-tax and after-tax contributions. Since you can’t choose to convert only after-tax contributions to a Roth IRA, the pro-rata rule is used to determine how much of the backdoor Roth IRA conversion is considered pre-tax and what portion is considered after-tax.

The pro-rata rule provides a two-step formula for determining pre-tax and after-tax contributions:

  • (nondeductible amount) / (total of all non-Roth IRA balances) = nontaxable percentage
  • (amount to be converted to Roth IRA) x (nontaxable percentage) = amount of after-tax funds converted to Roth IRA

Each subsequent backdoor Roth IRA conversion makes the pro-rata rule calculation more complex because some of the nondeductible amount will already have been moved over to the Roth IRA.

How to Set Up a Roth IRA to Make a Backdoor Contribution

To fully understand how to complete a backdoor Roth IRA, you may wish to discuss the option with a financial advisor. This strategy can be complex and involves more than simply ensuring that the process is set up correctly and knowing the differences between a Roth vs traditional IRA. A financial advisor may be able to help you with both short-term and long-term planning so that, should you choose to utilize a backdoor Roth IRA, you can do so strategically and minimize your potential tax burden. Below are some steps that may help.

Set Up a Traditional IRA

The first step to setting up a backdoor Roth IRA is to own a traditional IRA. If you:

  • don’t currently own a traditional IRA: Open an account and fund it with after-tax contributions if you wish to avoid the pro-rata rule.
  • already own a traditional IRA: Consider how the pro-rata rule and other regulations may impact the cost of making a backdoor Roth IRA conversion.

Make Contributions to the Traditional IRA

The traditional IRA will need to have funds in the account before a conversion to a Roth IRA can be made. However, there are limitations to how much can be contributed to a traditional IRA. IRA contribution limits are based on age and subject to change each year. As of 2023, anyone 50 and older can contribute up to $7,500 each tax year. The limit is $6,500 for everyone under 50 years old.

Set Up a Roth IRA

You’ll also need to establish a Roth IRA that the funds will roll into.

Convert the Traditional IRA Funds to Roth IRA Funds

Once the accounts have been established and there are contributions to convert, your brokerage can carry out the backdoor Roth IRA rollover.

Pay Taxes on the Converted Amount

You’ll have to pay the applicable taxes for the year the backdoor Roth IRA conversion is made. These can vary significantly, so you may wish to speak with a tax professional to determine the exact amount you’ll owe.

How to Convert a Traditional IRA to a Roth IRA

One key to using this retirement savings strategy is knowing how to convert a traditional IRA into a Roth IRA and what to watch out for beforehand. This is why it may be beneficial to speak with a qualified tax specialist or financial planner before moving any funds. A tax professional can help you determine whether a backdoor Roth IRA could be beneficial and the best time to initiate the rollover.

You will also need to contact your IRA administrator, who will provide specific instructions for the backdoor Roth IRA. This is often a simple process that requires you to fill out a form the brokerage then processes.

How much you convert to a Roth IRA—and when—can have a significant impact on your taxes. Ill-timed backdoor Roth IRA conversions are one of the most common pitfalls of this strategy. For example, without proper planning and timing, a backdoor Roth IRA could push you into a higher income tax bracket. The five-year backdoor Roth IRA rule is another factor you may wish to consider.

Should You Consider a Backdoor Roth IRA?

A backdoor Roth IRA is a retirement savings strategy that may not make sense for everyone. However, if you earn too much to contribute to a Roth IRA, it could be beneficial.

Another consideration that may factor into choosing a backdoor Roth IRA is your current and potential future tax rates. If you believe that your tax rate will be higher down the road, a backdoor Roth IRA could be more beneficial sooner rather than later because you are required to pay income taxes on the converted amount. You may also wish to consider the amount being converted: Since it adds to your annual income, this may also push you into a higher tax bracket.

Because a backdoor Roth IRA conversion cannot be reversed, you may wish to speak with a financial advisor or tax specialist about your unique situation before converting a traditional IRA account.

Precious Metals IRA Transfers Are a Backdoor Roth IRA Alternative

If you decide that a backdoor Roth IRA might not make financial sense—for example, if your income level allows you to make direct Roth IRA contributions—there’s another retirement savings strategy you may wish to consider. Assets from a traditional IRA or Roth IRA can be transferred to a precious metals IRA.

A precious metals IRA is an IRA that can contain traditional assets like stocks and bonds as well as assets like physical gold, silver, and other precious metals. It’s also self-directed, which means the account owner selects the assets included in the account and directs all account activity. Because alternative assets like precious metals can be included, this type of IRA can help add diversification to a portfolio and offer an additional way to save for retirement.

You can learn more about using physical precious metals for retirement savings by requesting a free Precious Metals IRA Kit .

Backdoor Roth IRA FAQs

What is the main difference between a Roth IRA and a backdoor Roth IRA?

A Roth IRA is a type of individual retirement account, while a backdoor Roth IRA is a financial strategy involving multiple individual retirement accounts. A backdoor Roth IRA is the process of moving funds from a traditional IRA to a Roth IRA.

Are there any income limits for the backdoor Roth IRA?

No. Unlike direct contributions into a Roth IRA, there are no income limits for making a backdoor Roth IRA conversion. There also are no limits to how much can be converted from the traditional IRA to the Roth IRA. The rules for making a backdoor Roth IRA rollover are similar to Gold IRA tax rules when transferring assets to a precious metals IRA.

Is a backdoor Roth IRA conversion legal?

Yes, but as with other financial strategies, there are rules and regulations you may wish to be aware of to ensure that the conversion is performed correctly. You may wish to discuss the option of a backdoor Roth IRA with a financial advisor before pursuing this option.

How does the pro-rata rule impact my Roth conversion?

The pro-rata rule affects how much is paid in taxes for the backdoor Roth IRA conversion. The pro-rata rule calculation determines how much of the total amount being converted is taxable based on the total percentage of nondeductible funds held in your combined traditional IRAs.

Can I reverse a backdoor Roth IRA conversion?

A backdoor Roth IRA conversion cannot be reversed. Reversing, or “re-characterizing,” Roth conversions was prohibited when the Tax Cuts and Jobs Act went into effect in 2018.

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