How to Start a 'Backdoor' Roth IRA (and When You Should)

If your income exceeds the limits for contributing directly to a Roth IRA, there's still a way to fund one through a strategy known as the "backdoor Roth IRA." This technique allows high-income earners to take advantage of the tax-free growth and tax-free withdrawals offered by Roth IRAs.

What is a "backdoor" Roth IRA?

A backdoor Roth IRA is not an official type of account: It's simply a strategic maneuver that involves making contributions to a traditional IRA and then converting those funds into a Roth IRA. This bypasses the income limits that normally restrict high-earners from contributing directly to a Roth.

If you file taxes as a single person, your Modified Adjusted Gross Income (MAGI) must be under $153,000 for tax year 2023 and $161,000 for tax year 2024 to contribute to a Roth IRA, and if you're married and filing jointly, your MAGI must be under $228,000 for tax year 2023 and $240,000 for tax year 2024.

How the backdoor Roth IRA works

Here are the basics of taking advantage of this backdoor strategy:

• Make a non-deductible contribution to a traditional IRA. Since your income exceeds the Roth IRA limits, you can contribute to a traditional IRA without taking a tax deduction.

• Convert the traditional IRA to a Roth IRA. After contributing to the traditional IRA, you can then convert those funds to a Roth IRA. This conversion is a taxable event, but since you didn't get a tax deduction on the contribution, you'll only pay taxes on any earnings.

• Pay taxes on the conversion. When converting, you'll owe income tax on any earnings in the traditional IRA account. If the conversion happens quickly after the contribution, there likely won't be significant earnings to tax.

IRA eligibility and limitations

There are no income limits for contributing to a traditional IRA or converting to a Roth IRA. The limit on annual contributions to an IRA are $7,000 in 2024 (up from $6,500 in 2023). Remember these contribution limits apply to the grand total contributions you make each year to all your traditional and Roth IRAs. As always, you can and should max out these limits, if possible.

It's important to note that if you have existing pre-tax funds in other traditional IRAs, the conversion will be partially taxable based on the pro-rata rule.

Getting started with your backdoor Roth IRA

To set up a backdoor Roth IRA, you'll need to open a traditional IRA account if you don't already have one. Then, make your non-deductible contribution and initiate the Roth conversion process according to your provider's requirements.

Consulting a tax professional is recommended, especially if you have existing IRA funds, to ensure you understand the tax implications. While the backdoor Roth strategy involves some extra steps, it can be a valuable way for high-income individuals to enjoy the benefits of a Roth IRA.