Hi Friendos,
Today’s topic is the backdoor Roth IRA. Before diving in, I have a couple of reminders:
- If you pay quarterly estimated taxes, remember that the June 16th deadline is coming up for Q2 2025. I wrote about estimated taxes in this article last year and this IRS FAQ page on estimated taxes is also very helpful.
- Next Saturday, June 14th, I am hosting my first monthly “Tax Me Anything,” a free session via Zoom on the second Saturday of every month, 11am-noon ET. The Zoom meeting ID is 897 1710 3456 and I am there to talk about anything related to taxes and personal finance. I hope you’ll drop in!
Ok, now on to the “backdoor Roth.” Last week I discussed IRA contributions, and how they come in traditional and Roth flavors. But, I said, “Roth IRA contributions have their own income limitation, but that only prevents higher earners from making a direct contribution (through the ‘front door’). Anyone can use a two-step process called a ‘back door Roth IRA’ to get around this rule.”
I’ll say that a little differently: you can be super high income and still max out an IRA contribution every year. If you are married and high income, both you and your spouse can each put $7k in Roth IRAs each year, even if only one of you has earned income. Then you can invest that money and owe no tax on that money or any of its investment earnings, so long as you leave it there until after age 59.5 (and follow other rules around withdrawals).
You’d be misled if you read IRS documentation that states “you can’t contribute to a Roth IRA” if you are single and your 2025 income exceeds $165,000. Don’t take it at face value! If you are single and your income is between $150k and $165k, the IRS publication says you can contribute to a Roth IRA, but the “the amount you can contribute is reduced.” That’s not quite right!
Here is a summary of the income phase-out threshold for the different tax filing statuses:
- $150k-$165k: Single, Head of Household, or Married Filing Separately and you did not live with your spouse during the year.
- $236k-$246k: Married Filing Jointly, Qualified Surviving Spouse
- $0-$10k: Married Filing Separately and you did live with your spouse during the year.
If your income is above those levels, you can contribute to a Roth IRA, just not directly. Instead, you execute a two-step process called a backdoor Roth IRA contribution. Here are the two steps:
- Contribute money to a traditional IRA.
- Convert that money to a Roth IRA.
That’s it, just those two steps.
There is one important rule to follow here to avoid triggering a tax bill, and that is: you cannot have any money sitting in a traditional IRA on December 31st of the year you do the conversion (step 2 of the process). No rollover IRA money. No prior year traditional IRA contributions. No traditional SEP IRA or traditional SIMPLE IRA. If you do have money in a traditional IRA at year end, you will be hit with the “pro-rata rule.”
When you convert a traditional IRA to a Roth IRA, you are not required to convert 100% of the money in the traditional IRA account, or to convert all accounts if you have multiple traditional IRA accounts. Imagine you have $28k sitting in a trad IRA, and then you contribute $7k contribution to it for 2025 (step 1 of the backdoor Roth process). Now there’s $35k in that account. Of that $35k total, $7k (20%) is after-tax money and $28k (80%) is pre-tax money. When you convert $7k in step 2 of the backdoor Roth process, the IRS does not let you designate which $7k is being converted. They consider it to be one big, mixed pool of money, so will treat the conversion as consisting of 20% after-tax money and 80% pre-tax money. You will owe income taxes on any pre-tax money converted. Your money is “pro-rated” hence, the “pro-rata rule.”
Andy Ives compares this to a cup of coffee: “Once a spoonful of cream goes into a cup of coffee, it becomes inexorably mixed and can never be removed as just cream. Each future sip will consist of a percentage of cream and a percentage of coffee.”
So, before you do your backdoor Roth contribution, you want to move existing pre-tax $ out of your traditional IRA and into another account like your current employer’s 401k plan. What if you don’t have a retirement plan at a W-2 job that will accept rollovers? No problem. Engage in some kind of self-employment/independent contractor income. Anything at all – walk a dog, detail your neighbor’s car, whatever. Then, get an EIN for your business (it’s free and fast to do online) and open a solo 401k. Fidelity will help you do this for no fees. Now you have a 401k that will accept your rollover.
Finally, I do recommend completing steps one and two of the process within the same calendar year. You are not required do so, but (1) it will make your tax preparation more straightforward and (2) if you convert right away, you are far less likely to have investment earnings on which you owe income tax.
Why does Congress effectively pretend that they’ve created a tax-advantaged vehicle that is only available to lower earners? This backdoor method is widely known, but Congress leaves the loophole open, year after year. I suppose this window dressing makes for convenient talking points.
If you want to learn more about backdoor Roth IRAs, I recommend the tutorial on the White Coat Investor blog and, if you prepare your own taxes, the step-by-step guidance on the Finance Buff blog for TurboTax and other tax software is fantastic. If you’d like some one-on-one guidance on executing a backdoor Roth, or want someone to check over your draft tax return to make sure your Form 8606 looks correct, get in touch and we can set up a meeting.
-Stephanie
Frequently Taxed Questions 