The Backdoor Roth IRA: How High Earners Can Get Tax-Free Money in Retirement

backdoor roth ira

If you’re a high earner, you may have heard that you’re not allowed to contribute to an IRA.

That’s because the IRS places limits on who can contribute to a Roth IRA and who can deduct their contributions to a Traditional IRA. If you make more than those limits, you’re supposedly out of luck.

And you’d be justified in feeling like that’s a pretty raw deal. After all, you work hard for your money and you want it to work hard for you.

And if you’re not allowed to contribute to an IRA, that’s up to $11,000 per year (for a married couple) that won’t get the special tax benefits an IRA offers.

Lucky for you, there’s a way around the rules.

Today we’re going to talk about the Backdoor Roth IRA, which is a process through which even high earners can contribute to a Roth IRA and get all the tax advantages that come with it.

Here’s what we’re going to cover:

  1. Who should consider a Backdoor Roth IRA?
  2. How to do the Backdoor Roth IRA
  3. Pitfalls to avoid

If you’ve previously been told that you earn too much to contribute to an IRA, today is your lucky day.

Who should consider a Backdoor Roth IRA?

The only people who should consider a Backdoor Roth IRA are people who earn too much money to directly contribute to either a Traditional or Roth IRA.

Here are the income limits for these accounts as of 2015. These limits are actually based on Modified AGI, which is a slightly different number than your regular income (gotta love the IRS!).

For a Roth IRA (source):

  • If you are single, your contribution is phased out from $116,000-$131,000.
  • If you are married filing jointly, your contribution is phased out from $183,000-$193,000.
  • If you are married filing separately, your contribution is phased out from $0-$10,000.

For a Traditional IRA, if you participate in a 401(k) or other employer plan (source):

  • If you are single, your contribution is phased out from $61,000-$71,000.
  • If you are married filing jointly, your contribution is phased out from $98,000-$118,000.
  • If you are married filing separately, your contribution is phased out from $0-$10,000.

For a Traditional IRA, if you DON’T participate in a 401(k) or other employer plan but your spouse does (source):

  • If you are married filing jointly, your contribution is phased out from $183,000-$193,000.
  • If you are married filing separately, your contribution is phased out from $0-$10,000.

If you don’t participate in a 401(k) or other employer plan and your spouse doesn’t either (or you’re single), then you can contribute to a Traditional IRA regardless of income.

And if your income is lower than these amounts, you can contribute to an IRA the normal way so there’s no need to worry about the Backdoor Roth IRA.

How to do the Backdoor Roth IRA

Alright, so if you make too much money to contribute to an IRA the normal way, how do you get around it?

Here are the basic logistics of the Backdoor Roth IRA, though there are also some potential pitfalls you’ll want to avoid. We’ll get into those pitfalls just below.

Step 1: Open a Traditional IRA

There are many places you can do this, and two of my favorites are Vanguard and Betterment.

Whoever you use, just make sure they offer good, low-cost index funds.

Step 2: Contribute to the Traditional IRA

Technically, you’re allowed to contribute to a Traditional IRA no matter what your income is. It’s just that your contribution won’t be deductible if your income is higher than the limits above.

So in this case you’ll be making what’s called a non-deductible contribution, which simply means that there’s no tax break on your contribution.

You don’t need to do anything to mark your contribution as non-deductible. It will automatically be counted that way at tax time because of your income.

Step 3: Convert it to a Roth IRA

Regardless of income, you are allowed to convert money within a Traditional IRA to a Roth IRA at any time.

The only catch is that you’ll be taxed on the conversion. And in normal circumstances that’s a significant consideration, since your Traditional IRA money will typically have been contributed tax-free and therefore the entire conversion would be taxed.

But in this case, since you made a non-deductible contribution to your Traditional IRA, the money was already taxed.

So when you convert to a Roth IRA, there really won’t be much of a tax impact at all. The amount you contributed can be converted tax-free, and you will only be taxed on any money you earn between the time you contribute and the time you convert.

If you do the conversion soon after your contribution, you won’t have earned much, if anything, and therefore your tax bill will be minimal.

All of which means that you’ll end up with money in a Roth IRA, ready to be withdrawn completely tax-free in retirement, just like if you had contributed the normal way.

Now, every investment company will have a slightly different process for actually doing this conversion, so I would recommend reaching out to their customer service and having them walk you through the steps.

But in all cases it should be fairly simple.

And as long as you can avoid the pitfalls we’ll talk about next, you can do this for both spouses.

Pretty cool!

Pitfalls to avoid

Every time I explain this to someone, they always give me that look that says they’re not quite sure any of this is actually legal.

And trust me, I get it. It definitely sounds a little sketchy.

Actually, it’s great that your BS meter goes off like that! When it comes to money, and ESPECIALLY when it comes to the IRS, it’s better to be safe than sorry.

But rest assured, the Backdoor Roth IRA is definitely legit. Many people do it every single year.

BUT there are some pitfalls to avoid to make sure it all works smoothly.

Pitfall #1: Other IRAs

In order for the Backdoor Roth IRA to work the way I described above, you CAN’T have ANY other Traditional IRA, SEP IRA, or SIMPLE IRA with money in it.

Here’s why:

When you convert to a Roth IRA, the IRS counts ALL of your IRAs as part of the conversion, even if you’re only doing it from one account.

And if you made deductible contributions to those other IRAs, then at least part of your conversion will be taxed.

As an example, let’s say you take the steps above to make a non-deductible $5,500 contribution. But let’s say you also have $25,000 in a different Traditional IRA, and that money was contributed tax-free in years past.

If you convert the $5,500 from your new account, the $25,000 will also be counted as part of the conversion. Which means that most of that conversion will be counted as money that has never been taxed, and therefore needs to be taxed now.

The calculation works like this:

  • $30,500 total IRA money
  • The $5,500 non-deductible portion is 18% of that
  • The $25,000 deductible portion is 82% of that
  • So 18%, or $992, of the conversion will NOT be taxed
  • And 82%, or $4,508, of the conversion WILL be taxed

Not so great.

Luckily there’s a workaround.

If you have a 401(k), 403(b), or 457(b) retirement plan through work, or if you have a Solo 401(k) through your business, you may be able to rollover that deductible IRA money into one of those accounts before doing the Backdoor Roth IRA.

Doing so would remove all of the complications we just talked about. You would no longer have any other Traditional IRA money and would therefore avoid any unwanted tax consequences.

So, if you have any existing Traditional IRAs, SEP IRAs, or SIMPLE IRAs, make sure to handle this step before you do the Backdoor Roth IRA.

Pitfall #2: How long to wait

There’s a big question around how long you should wait between making your non-deductible IRA contribution and doing the Roth IRA conversion.

Some people feel like it’s fine to do it right away. Others recommend waiting until you have a statement showing the money in your Traditional IRA. And others recommend waiting an entire year. (Here’s an article with all you could ever want to know about this.)

There are two main reasons why there’s such wide disagreement:

  1. The IRS has a rule called the step transaction doctrine, which essentially just means that they’re allowed to decide that a series of steps is illegal if the end result is against the spirit of IRS rules, even if each individual step is perfectly the legal. The people who recommend waiting feel like the longer you wait, the less likely it is that the IRS will be able to use this rule against you.
  2. On the flip side, there isn’t a single case (as far as I know) of anyone getting into trouble for this, or even of the IRS mentioning that people might get in trouble for it. This is why some people say you can do the conversion immediately.

I don’t have a specific recommendation for you, simply because I don’t know any better than anyone else exactly what the IRS might decide to do.

So I would simply encourage you to use the information above to make whatever decision feels right to you.

Take advantage!

The Backdoor Roth IRA definitely takes more effort than a regular contribution, but it’s absolutely worth it if you make too much to contribute otherwise.

The alternative is likely investing the money in a regular old taxable account instead, which is still a good option. But it’s nowhere near as good as money that will be completely tax-free down the line.

So if you have the opportunity to use the Backdoor Roth IRA, I would definitely try to take advantage of it.

Have you ever done this yourself? What questions do you have about making it work?

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  • Linden November 10, 2015

    Good article! I like to call this a “Two-step Roth” rather than a “Backdoor Roth” – it sounds less sketchy that way…:)

  • Brent Applegate November 11, 2015

    Great post. I did this today for my spouse based on your article. Nice that the IRS counts IRAs to a specific social security number, so if only one spouse has other IRAs (Pitfall #1) then the other may be able to do this if he/she doesn’t. Thanks again!

    • Matt Becker November 11, 2015

      That’s awesome Brent! Nice work being so proactive!

  • Nick November 12, 2015

    Hey Matt thank you for a well written and clear article. I always thought I wasn’t a candidate for this technique because I have a SIMPLE IRA from a past employer that I don’t want to pay taxes on…now I will look into rolling that into my 401K first.

    Having said that, I’m now curious about the strategy with these backdoor Roths. Are people repeating the process you describe annually? Pardon my naivety but that seems so silly that the gov’t would have an income limit on Roth contributions and then let people circumvent the limit so simply and repeatedly every year. So should I put $5500 in a non deductible IRA for both my wife and me and repeat the Roth conversion every year?

    Thanks!

    • Matt Becker November 12, 2015

      I’m glad it was helpful Nick!

      I can’t give you any specific recommendations since I don’t know the details of your situation, but I will say that yes, people are doing exactly as you have described, repeating this process each year for both spouses. I agree that it’s kind of silly, but our tax code has many silly loopholes like this. Might as well take advantage where you can!

  • Brendan November 22, 2015

    One thing I’m unclear on is rollover IRAs. Conceptually, they behave like T-IRAs, but in this instance, I’m uncertain if that’s true. I’ve got a rollover IRA that consolidated some previous employer 401(k)s. If I open a stand alone T-IRA for the purposes of backdoor Roth conversions, is your understanding that I would be subject to the proportional taxation you described?

    • Matt Becker November 23, 2015

      Good question Brendan. And yes, it would be treated just like a Traditional IRA in this case, assuming that the money has all been tax-deferred to this point.

      • Brendan November 24, 2015

        Well that’s too bad 🙂

  • Carole E. February 11, 2016

    Great article! I have been researching how we can put money into my husband’s IRA since our MAGI is over 193K. I think I understand how to do this, but I want to ask a clarifying question. For demonstration, if my husband has 7k in his current Traditional deductible IRA and no other IRA, we can add money, say 5500, to his current IRA and then convert just the 5500 to a Roth IRA. So we don’t have to convert any of the other 7k at the same time? Am I understanding this correctly? Also, I have my own IRA that was a rollover from a former employer, but from what I understand on another person’s comment, the IRS only looks at IRAs for that SSN, not for the spouse also, even though we file MFJ?

    Thanks!

    • Matt Becker February 11, 2016

      Good questions Carole. So first, you are correct that only the individual’s IRAs are counted. The spouse’s IRAs are ignored.

      Second, your husband would need to do something with his Traditional IRA money before doing the conversion, or else he would be partially taxed on the conversion. If he can roll it into a 401(k), that should solve this problem. This is what’s described under “Pitfall #1: Other IRAs”.

      I hope that clears things up, but let me know if you have any more questions!

  • Chris March 26, 2016

    Great article. I read about this a few years ago and have been doing this for the past 3-4 years. Talked with my tax advisor and he said no issues with it either.

    Also for Carole E.’s question…

    Both my wife and I had traditional IRAs before we came across this backdoor Roth strategy. Since the IRS treats us as separate individuals for retirement, my wife and I handled this separately and differently.

    My wife’s IRAs had small gains, so it made sense for us to do a full conversion of her existing traditional IRAs based on our plan to do the backdoor Roth strategy for the next 20 years. We did the full conversion in the first year, so now we just do the backdoor Roth for her every year without having to do any other proportionate calculations to figure out taxes.

    For me, on the other hand, I had some huge gains on some lucky investments in my IRAs. If I did a full Roth conversion of my existing IRAs, I would have a big, big tax bill. So it didn’t make sense for me to do a conversion. It also didn’t make sense to do the backdoor Roth annually because it would be like Matt’s example where 82% of the conversion would be applied to my traditional IRA with gains (from which I’d have to pay taxes for the conversion), so I’d only get 18% of the tax-free Roth conversion benefit. In my case it would be an even worse split.

    Every year now, we contribute $5500 into my wife’s non-deductible IRA AND immediately convert it to a Roth. We also make a non-deductible $5500 contribution to my IRA BUT leave it as is without doing the backdoor Roth. Even without the backdoor Roth, it’s still a good tax-deferred vehicle.

    Hope this helps.

  • Ashok Chotai February 6, 2019

    Hi Matt – thanks for the article. Has anything changed since this article was published in 2015 ?

    • Matt Becker February 6, 2019

      You’re welcome Ashok. The contribution limits have changed, but otherwise things are the same.

  • Christin February 13, 2019

    Matt-

    Thanks for this information. Question for you…my spouse and I have been contributing to our traditional IRAs and then immediately converting it over to a Roth. My husband is unemployed but we continue to make contributions to his IRA (then convert to Roth). When I was entering our taxes in turbotax (I’m used to do the backdoor roth IRA entry in turbotax), I got a question this year that i haven’t seen…

    It says that i can deduct my husbands IRA contribution of $5,500 and asks me if i want to do this or make it nondeductible. Why do i have the option of making his deductible? and do i want to do this since the contributions he made into the traditional IRA were converted to a Roth i think I want the entire amount to be “nondeductible” –is that correct that I should make it all nondeductible?

    • Matt Becker February 14, 2019

      Those are good questions Christin and I would encourage you to ask a CPA. I would love to help, but the answers depend on the specifics of your tax situation.

  • Jason March 17, 2019

    Matt – thank you for this article. If I do this annually Will I have multiple ROTH IRAs or do I just roll it into the same ROTH every year?

    • Matt Becker March 18, 2019

      You’re welcome Jason. You can generally convert into the same Roth IRA every year.

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