What is a Backdoor Roth Contribution?
January 4, 2023
The term “Backdoor Roth” has been floated around the political sphere recently. There has been an increased push by politicians to close the loophole that allows this strategy to exist. But what is a Backdoor Roth and who can benefit from using the strategy?
To understand the Backdoor Roth strategy, we first must look at who is eligible to contribute to a Roth IRA. To contribute to a Roth IRA in 2023, single filers must have income under $153,000 or $228,000 for married filing jointly. While this income limit essentially bars high-income earners from contributing to a Roth IRA, a Backdoor Roth creates a loophole to this limitation.
To execute a Backdoor Roth, a person makes a non-deductible contribution to a Traditional IRA “Pre-tax IRA” and then immediately converts the funds to a Roth IRA. There is no income limit for who can contribute to a Traditional IRA on a non-deductible basis and there is no income limit on who can make a Roth conversion. Essentially you are putting after-tax dollars in a pre-tax IRA and then immediately converting those funds to Roth. The taxes owed on this transaction would be $0 since the funds deposited are already after tax.
There is a very important caveat to this strategy. Funds converted to a Roth are taxed on a pro-rata basis, which means proportional to all your IRA accounts. You cannot have a traditional IRA with an existing balance and successfully execute this strategy. If you do have an existing balance in any IRA accounts, you could owe tax when making the Roth conversion. You can, however, have a workplace 401k or qualified plan without issue. It may be possible to roll your traditional IRA into your current 401k if you want to take advantage of this strategy.
High-income earners who already max out their workplace 401k may benefit from putting $6,500-$7,500 in a Roth IRA over depositing in a taxable investment account. If your taxable income is low, or you aren’t currently working, you may consider a normal Roth Conversion* as opposed to this strategy. Contact one of our Certified Financial Planners if you would like to learn more or have us look at your specific situation.
* IRA account owners should consider the tax ramifications, age and income restrictions in regard to executing a conversion from a Traditional IRA to a Roth IRA
Dillon Hakes, CFP
Portfolio Manager
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