Backdoor Roth IRA: Understanding the loophole that gives high-income earners the tax benefits of a Roth IRA (2024)

FAQs

Backdoor Roth IRA: Understanding the loophole that gives high-income earners the tax benefits of a Roth IRA? ›

A backdoor Roth IRA is a strategy rather than an official type of individual retirement account. It is a technique used by high-income earners—who exceed Roth IRA income limits for making contributions—to contribute indirectly–through the back door–by converting their traditional IRA to a Roth IRA.

A backdoor Roth can be created by first contributing to a traditional IRA and then immediately converting it to a Roth IRA to avoid paying taxes on any earnings or having earnings that put you over the contribution limit.

Backdoor Roth

If you earn too much to make deductible contributions to a traditional IRA, you can still make after-tax contributions, up to the annual limit, and then convert them to a Roth.

Cons: All or part of a backdoor Roth IRA conversion could be a taxable event. You may have to pay federal, state, and local taxes on converted earnings and deductible contributions. Conversions could kick you into a higher tax bracket for the year.

Backdoor Roth IRA: A backdoor Roth IRA is a strategy for high-income earners who exceed Roth IRA contribution income limits. It involves making non-deductible contributions to a traditional IRA and then converting those funds into a Roth IRA. This allows high allows high earners to take advantage of Roth IRA benefits.

The five-year rule could foil your withdrawal plans if you don't know about it ahead of time. This rule for Roth IRA distributions stipulates that five years must pass after the tax year of your first Roth IRA contribution before you can withdraw the earnings from the account tax-free.

Yes. Backdoor Roth IRAs are still allowed in 2024. However, there has been talk of eliminating the backdoor Roth in recent years. And the future is, of course, difficult to predict.

The term “backdoor” reflects the indirect nature of this contribution method. As of 2024, single filers with modified adjusted gross income (MAGI) above $161,000 and married couples above $240,000 are ineligible to contribute to a Roth IRA directly.

High earners who exceed annual income limits set by the Internal Revenue Service (IRS) can't make direct contributions to a Roth individual retirement account (Roth IRA).

If your MAGI is $230,000 or greater, the amount you can contribute is reduced or eliminated altogether. If you are married filing separately (and you lived with your spouse during the year), you can make a reduced contribution if your MAGI is below $10,000. Above that level, you can't save into a Roth IRA at all.

Do you get taxed twice on backdoor Roth? ›

To be clear, no converted funds would get double-taxed, but some circ*mstances can result in a taxable transaction. That's where the rules get more complicated. (And that's why it's a good idea to consult with a financial advisor when deciding whether a backdoor Roth makes sense for you.)

No, the backdoor Roth is not considered illegal. The IRS does not classify the backdoor Roth as a form of tax evasion but could best be described as a form of tax avoidance. If you have any misgivings about this financial maneuver in a specific situation, you can consult a more experienced tax professional.

Despite the nickname, the “Rich Person's Roth” isn't a retirement account at all. Instead, it's a cash value life insurance policy that offers tax-free earnings on investments as well as tax-free withdrawals.

Depending on how much money is in the account and what your income tax rate is, the amount of tax you owe could be huge. Even given that, the backdoor Roth IRA strategy can have advantages—especially for high earners.

Backdoor Roth IRAs can be great for doctors and other high-income earners planning for retirement. However, they can be tricky. Therefore, it is essential to report them properly on your tax return to avoid unnecessary taxes. Be sure to consult your CPA if you have specific questions regarding your situation.

The point of a Roth IRA is that it's already taxed money that grows tax-free. So, to convert your traditional IRA to a Roth IRA you'll have to pay ordinary income taxes on your traditional IRA contributions in the year of the conversion before they “count” as Roth IRA funds.

Backdoor Roth IRA income limits

The phaseout occurs between $146,000 and $161,000 for single filers and $230,000 and $240,000 for joint filers in 2024. The backdoor method allows those with higher incomes who can't contribute in the typical manner to still take advantage of a Roth IRA.

While it doesn't look like they'll be eliminated in 2024, the future of the Backdoor Roth IRA remains a target of proposed legislation. Some legislative efforts have already been taken to limit Roth IRAs or to change tax brackets and RMDs in the future.

The backdoor Roth may not last forever

If the IRS decides that the loophole is a violation, you could owe a 6% excise tax for overfunding your Roth. And if restrictions do come into play at some point, they could require backdoor Roth converters to pay a penalty, or they might include a grandfather clause.