Why Do a Backdoor Roth and How Does It Work?

A Roth IRA offers a way to save for retirement, providing tax-free withdrawals in retirement, provided certain conditions are met. This tax advantage, along with the absence of required minimum distributions (RMDs) during the owner’s lifetime, makes Roth IRAs attractive. However, direct contributions to a Roth IRA are subject to income limitations, which can prevent many higher-income individuals from utilizing these benefits. For those whose income exceeds these thresholds, a strategy known as the “backdoor Roth” allows them to access the advantages of a Roth IRA. This approach involves a specific two-step process.

Understanding Roth IRA Income Limits

The ability to contribute directly to a Roth IRA is tied to an individual’s Modified Adjusted Gross Income (MAGI). Each year, the Internal Revenue Service (IRS) sets specific income thresholds that determine eligibility for direct Roth IRA contributions. For instance, in 2025, single filers with a MAGI below $150,000 can make a full Roth IRA contribution. Eligibility begins to phase out at $150,000 and is completely phased out at $165,000 or more.

For those married filing jointly, the income threshold for a full contribution in 2025 is a MAGI below $236,000. Eligibility phases out between $236,000 and $246,000, and is eliminated at $246,000 or more. These income limits mean many individuals with higher earnings cannot contribute directly to a Roth IRA.

The annual contribution limits for IRAs, including both Traditional and Roth, are also set by the IRS. For 2025, individuals under age 50 can contribute up to $7,000, while those age 50 and older can contribute up to $8,000. If an individual’s MAGI exceeds the Roth IRA income limits, they are no longer eligible to contribute directly. This ineligibility is why high-income earners explore the “backdoor” method, allowing them to bypass direct contribution restrictions and still enjoy the long-term tax advantages of a Roth IRA.

The Backdoor Roth Contribution Process

Executing a backdoor Roth IRA involves a specific sequence of steps, beginning with a contribution to a Traditional IRA. The initial step requires making a non-deductible contribution to a Traditional IRA. This means the individual does not claim a tax deduction for this contribution on their tax return, ensuring the money is considered after-tax. Individuals can contribute to a Traditional IRA regardless of their income level.

Once the non-deductible contribution is made, the next step involves converting those funds to a Roth IRA. This conversion is typically initiated through the financial institution holding the Traditional IRA account. While there are income limits for direct Roth contributions, there are no income limits for converting a Traditional IRA to a Roth IRA.

It is advisable to perform the conversion shortly after making the non-deductible contribution. This minimizes the time any potential earnings can accrue within the Traditional IRA. If earnings accumulate between the contribution and conversion, those earnings would be considered pre-tax and become taxable upon conversion. Converting promptly reduces the amount subject to potential taxation, aligning with the goal of moving after-tax money into a Roth account.

Key Considerations for a Backdoor Roth

Individuals pursuing a backdoor Roth conversion must understand specific rules and reporting requirements to avoid unexpected tax implications. One important concept is the “pro-rata rule,” also known as the IRA aggregation rule. This rule applies if an individual holds any pre-tax funds across their Traditional, SEP, or SIMPLE IRAs. The IRS views all non-Roth IRA accounts as a single, aggregated account for tax purposes.

If an individual has both pre-tax and after-tax money across their aggregated IRA accounts, any Roth conversion will be considered a proportional mix. For example, if 80% of an individual’s total IRA balance is pre-tax and 20% is after-tax, then 80% of any conversion will be deemed taxable, even if the conversion amount originated from a recent non-deductible contribution. This can significantly reduce the tax efficiency of the backdoor Roth strategy for those with substantial pre-tax IRA balances.

Proper tax reporting is important for a backdoor Roth. Individuals must file IRS Form 8606, “Nondeductible IRAs,” with their tax return for any year a non-deductible Traditional IRA contribution is made or a Roth conversion occurs. This form informs the IRS that the Traditional IRA contribution was made with after-tax dollars, establishing a “basis” in the IRA. Reporting this basis is crucial to prevent the same money from being taxed again upon withdrawal. Failure to file Form 8606 can result in a penalty and may lead to double taxation of the non-deductible contributions.