How to do a Backdoor Roth

If your income is too high to contribute to a Roth IRA, you may have other options, but it’s not super simple. Let us help you break down your alternatives and specifically talk about what a Backdoor Roth is and whether it can help you.

If you are a high earner, meaning your income as a single tax filer is over $140,000 (2021) or as a married couple filing jointly is over $208,000 (2021), then your high income limits you from being able to make direct contributions to a Roth IRA. This is unfortunate as Roth IRAs allow you to invest for tax-free growth. If you contributed to a Roth IRA and your income reached or exceeded the income phase-out limits,  you’ll have to do a return of the excess contribution. If you can’t contribute to a Roth IRA, you may be able to make non-deductible contributions to a Traditional IRA. It can be advantageous to have both Traditional and Roth IRA investment accounts because they can help provide more tax efficient distribution strategies in retirement.

Even if your income exceeds the above limits, you can still consider a Roth conversion or a Backdoor Roth. This term “backdoor” makes it sound like you’re doing something sneaky, but it is completely legitimate, although a little complicated.

First, something you should ask yourself is “Are you getting the most from your 401(k)s?”

If you’re maxing your match in your company’s 401k, could you be contributing more? Does your company offer access to a Roth 401k? This would help you if you want to set aside post-tax retirement monies. They are similar to a Traditional 401k, but the Roth 401k side grows tax free.  Also, Roth 401Ks do not have income participation phase outs like Roth IRAs do. So even if you do not qualify for a Roth IRA because you exceed the IRS’s set income limits, you can make a post-tax contribution to a Roth 401k, which allows you to pay no tax on withdrawals after you are 59 ½.

The bottom line is don’t consider a backdoor Roth if you have a Roth 401k option at work. 

Don’t forget that the annual plan contribution limit in 2021 is $19,500 and an extra $6,500 if you are 50 and wiser–much higher than the IRA contribution limits.

How to do a Roth conversion?

3 steps to a Backdoor Roth:

  1. Open a Roth IRA
  2. Open a Traditional IRA. *for 2021 you can contribute up to $6,000 (if you’re 50 and wiser, you can contribute $7,000).
  3. Convert the Traditional IRA to your Roth IRA as soon as available. There is no income phase-out on conversion limits.

However, there is a pro-rata rule that you will have to abide by. The pro rata rule states that when IRA accounts are converted partially or fully to Roth IRA accounts, the taxes will be calculated proportionally to the percentage of after-tax vs. before-tax contributions to the Traditional IRA.  Therefore, if you already have pre-tax IRA balances before the non-deductible Traditional IRA contribution you intend to convert, you will not be able to execute the full benefits of a Backdoor Roth.

If you’re considering this option, it is highly recommended that you have a CPA and a financial advisor to help track and advise you on this process. You should only consider a Backdoor Roth if all of these conditions apply to you:  your income exceeds the income requirements, you don’t have a Roth 401k option at work, and you don’t already have significant pre-tax IRA (traditional, rollover, SEP, SIMPLE) assets. Conversions are beneficial if you know your tax bracket will be higher in the future and you’re investing for the long-haul toward retirement.