What Is a Backdoor Roth IRA and How Does It Work?
Learn the mechanics of a backdoor Roth IRA, a retirement strategy for those who exceed income limits. Understand the conversion process and its tax implications.
The Backdoor Roth IRA is not an official retirement account but a strategy used by individuals with high incomes to contribute to a Roth IRA. It is a legal method to navigate the income limitations that prevent direct contributions. By using this two-step process, individuals who are otherwise ineligible can still benefit from the tax-free growth and withdrawals that a Roth IRA offers in retirement. A Roth IRA is a popular retirement savings vehicle where contributions are made with after-tax dollars, which allows for tax-free withdrawals of contributions and earnings in the future, provided certain conditions are met.
Roth IRA Contribution Limitations
The Internal Revenue Service (IRS) uses a metric called Modified Adjusted Gross Income (MAGI) to determine an individual’s eligibility to make direct contributions to a Roth IRA. MAGI is calculated by taking your Adjusted Gross Income (AGI) from your tax return and adding back certain deductions. If your MAGI exceeds specific thresholds set by the IRS, your ability to contribute directly to a Roth IRA is either reduced or eliminated entirely.
For 2025, the income phase-out range for single filers and heads of household is $150,000 to $165,000. For those who are married and filing jointly or are qualifying widow(er)s, the range is $236,000 to $246,000. If your MAGI falls within these ranges, you can only make a partial contribution. If your MAGI is above the upper limit of these ranges, you cannot contribute to a Roth IRA for that tax year at all.
The contribution limits for IRAs for 2025 are $7,000, with an additional $1,000 catch-up contribution allowed for individuals aged 50 and over.
The Backdoor Roth IRA Process
The Backdoor Roth IRA strategy is a two-step process that begins with making a contribution to a Traditional IRA. Unlike Roth IRAs, there are no income limitations on who can contribute to a Traditional IRA. The first action is to open and fund a Traditional IRA with any brokerage firm.
This contribution is made on a non-deductible basis, meaning you do not claim a tax deduction for the amount you contribute, as high-income earners are often ineligible to deduct these contributions if covered by a workplace retirement plan. The contribution for a specific tax year can be made up until the tax filing deadline for that year, which is typically April 15th of the following year.
The second step is to convert the funds from the Traditional IRA to a Roth IRA. After the initial contribution to the Traditional IRA has settled, you then initiate a transfer of those funds into a new or existing Roth IRA. It is recommended to perform the conversion shortly after the contribution settles to minimize the potential for the funds to generate earnings while in the Traditional IRA, as any such earnings would be subject to income tax upon conversion.
The Pro-Rata Rule Explained
The pro-rata rule can have tax implications if you hold other IRA assets. The IRS requires that for tax purposes, all of an individual’s Traditional, SEP, and SIMPLE IRAs be treated as one single account. This is known as the aggregation rule. When you convert funds from a Traditional IRA to a Roth IRA, the pro-rata rule dictates that the conversion is made proportionally from your pre-tax and after-tax funds held across all of these aggregated IRAs.
The taxability of the conversion depends on this proportion. If you only have after-tax money in your Traditional IRAs, the conversion to a Roth IRA is generally tax-free. However, if you have existing pre-tax funds in any Traditional, SEP, or SIMPLE IRAs, the conversion will be partially taxable because the rule prevents you from only converting the non-deductible portion.
To illustrate, imagine you have $93,000 in a pre-tax rollover IRA and make a $7,000 non-deductible contribution to a new Traditional IRA, bringing your total IRA balance to $100,000. Of this total, $93,000 (93%) is pre-tax money and $7,000 (7%) is after-tax money. If you then convert $7,000 to a Roth IRA, the pro-rata rule dictates that 93% of that conversion ($6,510) will be a taxable distribution from your pre-tax funds, and only 7% ($490) will be a tax-free conversion.
To avoid the pro-rata rule, some individuals with existing pre-tax IRA balances may consider rolling those funds into their current employer’s 401(k) plan, if the plan allows for it. To avoid the pro-rata calculation, your Traditional, SEP, and SIMPLE IRA balances must be zero by December 31st of the year you perform the Roth conversion.
Tax Reporting Requirements
Properly documenting a Backdoor Roth IRA on your tax return is necessary to ensure compliance with IRS regulations. The primary form used is IRS Form 8606, Nondeductible IRAs. This form is used to report non-deductible contributions to Traditional IRAs, track your after-tax basis, and report conversions to a Roth IRA.
When you file your taxes for the year of the non-deductible contribution, you will complete Part I of Form 8606. When you complete the conversion to the Roth IRA, you will report this transaction in Part II for the year the conversion occurred. This part of the form is where the pro-rata calculation is performed to determine the taxable amount of the conversion.
In addition to Form 8606, you will receive other tax forms from your financial institution. You will receive a Form 5498, IRA Contribution Information, which reports the contribution and the conversion. You will also receive a Form 1099-R, which reports the distribution from your Traditional IRA that was converted to the Roth IRA.