Income Too High To Contribute to Your Roth IRA? Enter the Backdoor Roth IRA

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Written by: Patrick Marcinko, CFP® | Bogart Wealth

If you’ve been scrolling through social media lately, you’ve probably seen endless posts about contributing to a Roth IRA. And it’s true, Roth IRAs are a powerful tool for long-term growth, offering tax-free growth and withdrawals in retirement. But here’s the catch: if your income exceeds certain limits, you might find yourself ineligible to contribute directly. If that’s the case, don’t stop reading just yet! Even if your income is above the Roth thresholds, there’s still a way to fund your account. Enter the Backdoor Roth IRA strategy.

What is a Backdoor Roth IRA?

A Backdoor Roth contribution allows you to fund your Roth IRA despite your income level. Essentially, you make a non-deductible contribution to a traditional IRA, which creates an after-tax basis in the account. Then, you convert the money in your traditional IRA over to your Roth IRA. While there are some nuances to this strategy, let’s break down each step of making a Backdoor Roth contribution.

Eligibility: Who Can Use the Backdoor Roth IRA?

To be eligible for a Backdoor Roth IRA, your income must exceed the limit for direct Roth IRA contributions. For 2024, if your modified adjusted gross income (MAGI) is over $161,000 for single filers or $240,000 for married couples filing jointly, you won’t be able to contribute directly to a Roth IRA.

However, there’s no income limit for converting a traditional IRA to a Roth IRA, which is where the Backdoor Roth IRA strategy comes into play.

Step-by-Step Process to Open a Backdoor Roth IRA

Here’s a guide to using the Backdoor Roth IRA strategy:

  1. Open a Traditional IRA
    The first step is to open a traditional IRA. There are no income limits for contributions, but your contribution might not be tax-deductible if your income is high.

  2. Make a Nondeductible Traditional IRA Contribution
    You can contribute up to $7,000 (or $8,000 if you're 50 or older) in 2024. If your income exceeds certain limits, this contribution will be non-deductible.

  3. Convert to a Roth IRA
    After funding your traditional IRA, convert the money to a Roth IRA. There are no income limits for this conversion, so it works no matter how much you earn. You may want to work with your advisor or custodian to handle the conversion process.

  4. Pay Taxes on Earnings
    If there are any earnings in your traditional IRA before converting to a Roth IRA, you’ll owe taxes on that growth.

Benefits of a Backdoor Roth IRA

What are the benefits of making backdoor contributions?

  • Tax-Free Growth: Once the money is in your Roth IRA, any investment growth will grow tax-free. If certain requirements are met, you can also make tax-free withdrawals in retirement. Who wouldn’t love that?

  • No Required Minimum Distributions (RMDs): Unlike traditional IRAs, Roth IRAs don’t require minimum distributions, giving you more flexibility in retirement.

  • Tax Diversification: Having a mix of pre-tax, Roth, and taxable assets in retirement provides flexibility to manage your tax brackets and overall lifetime tax liability. The value lies in having assets spread across different tax buckets.

Considerations

Before jumping into a backdoor Roth contribution, be sure to consider:

  • Pro-Rata Rule: If you have other traditional IRA accounts with pre-tax contributions, the IRS requires you to use a pro-rata formula when converting to a Roth IRA. This could make part of your conversion taxable. If you have a balance in a traditional IRA, it’s important to consult with your financial professional or tax advisor to understand how this might affect the tax implications of the backdoor Roth strategy.

  • Tax Filing: The Backdoor Roth strategy can add extra steps when filing your taxes, as it involves non-deductible contributions and conversions. It's important to work with a tax professional to ensure everything is reported on your return.

Conclusion

The Backdoor Roth contribution strategy can supercharge your retirement savings. It’s an excellent option for high-income earners who still want to take advantage of the tax benefits of a Roth IRA. Don’t wait—talk to your advisor about whether this strategy should be part of your savings plan.

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