Understanding the backdoor Roth IRA—How it works and why you should consider it

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4 days ago

Retirement planning can feel like solving a jigsaw puzzle, especially for high-income households. If you're earning too much to qualify for a Roth IRA directly, you might assume that the Roth IRA's powerful tax advantages are out of reach.
Think again. The Backdoor Roth IRA is a legal and strategic way for high-earners to enjoy the benefits of a Roth IRA without income limits standing in the way.
This guide from Range explores how a Backdoor Roth IRA works, why it's valuable for high-net-worth households, and the specific steps and tax implications involved.
Backdoor Roth IRA Explained
High-income earners can bypass Roth IRA income limits legally.
Tax-free growth and withdrawals with no required minimum distributions.
Contributions to a traditional IRA can be converted into Roth.
A Backdoor Roth IRA isn't a special account—it's a tax strategy. It allows individuals who make too much to contribute directly to a Roth IRA to fund one indirectly. Here's how it works in simple terms:
First, you contribute after-tax dollars to a traditional IRA.
Then, you convert that traditional IRA to a Roth IRA, enabling you to enjoy tax-free growth and tax-free withdrawals in retirement.
It's an elegant workaround for those who want to take advantage of a Roth IRA's unique perks but are above the income eligibility limits.
For high-income households, the Backdoor Roth IRA is more than a loophole—it's a strategic tax planning tool that comes with significant benefits for long-term wealth building. Here's why you should consider it:
1. Tax-Free Growth
Once your money is in a Roth IRA, it grows completely tax-free. Unlike traditional IRAs where you'll eventually owe taxes on investment gains, a Roth lets your wealth grow and compound without interruption from taxes.
2. Tax-Free Withdrawals
When you withdraw funds from a Roth IRA in retirement, you won't pay a penny in taxes on the contribution or the earnings (as long as you meet eligibility requirements).
3. No Required Minimum Distributions (RMDs)
Unlike a traditional IRA, a Roth IRA does not require you to start withdrawing funds at age 73. This flexibility allows your retirement savings to grow for as long as you like—perfect if you're planning to pass wealth on to your heirs.
4. Access for High-Income Earners
Normally, individuals with a modified adjusted gross income (MAGI) above a certain threshold cannot directly contribute to a Roth IRA. For 2025, the phase-out ranges are:
Single filers: $150,000–$165,000
Married filing jointly: $236,000–$246,000
With a Backdoor Roth IRA, these limits no longer apply.
Here's a step-by-step breakdown of how to create a Backdoor Roth IRA.
Step 1. Contribute to a Traditional IRA
Start by contributing after-tax dollars to a traditional IRA. The IRS allows annual contributions of up to $7,000 (or $8,000 for those aged 50 or older in 2025).
Since your contribution is made with after-tax money, it's nondeductible, meaning you won't get a tax break on the contribution.
Step 2. Convert to a Roth IRA
Next, convert your traditional IRA to a Roth IRA. Most financial institutions allow you to do this easily online or with a quick call to your advisor.
The conversion moves your funds into the Roth account, where future earnings will grow tax-free.
Step 3. Pay Taxes on Any Pre-Tax Balances
If your traditional IRA contains pre-tax contributions or earnings, you'll owe income taxes during the conversion. These taxes are calculated based on the pro-rata rule, which we'll cover below.
Special Note on Timing
Many financial advisors suggest completing the conversion as soon as possible after the traditional IRA contribution. This minimizes any taxable earnings generated between the contribution and conversion.
Pro-Tip for Tax Efficiency
To minimize complexities, some high-income earners choose to maintain no other pre-tax IRA balances. Why? The pro-rata rule could make a portion of your conversion taxable.
IRS Pro-Rata Rule Explained
The pro-rata rule applies if you have pre-tax funds in any traditional IRA accounts. For example, if 75% of your total IRA balances are pre-tax, 75% of the conversion will be taxable.
Example:
Traditional IRA #1 (Pre-Tax): $18,000
Traditional IRA #2 (After-Tax): $6,000
Total IRA Balance: $24,000
Conversion Amount (IRA #2): $6,000
Taxable Portion = 75% of $6,000 = $4,500
By avoiding pre-tax IRA balances via rollovers to 401(k)s, you simplify the Backdoor Roth strategy.
Here are some scenarios where a Backdoor Roth IRA may be a smart choice:
You're a high-income earner: If your salary exceeds Roth contribution limits, a Backdoor Roth unlocks access to this tax-advantaged account.
You anticipate higher future tax rates: Roth IRAs allow you to 'lock in' your current tax rate, potentially saving you money in retirement.
You want flexibility in retirement: With no RMDs, Roth IRAs let you manage your withdrawals on your terms.
While the Backdoor Roth IRA can be a powerful strategy, there are some challenges to be aware of:
Tax Complexity – The pro-rata rule can make tax calculations tricky. You may benefit from consulting a tax professional to optimize the strategy.
Funding Limits – You can only contribute up to $6,500 annually (or $7,500 for those 50+).
Five-Year Rule – Withdrawals from converted funds may trigger penalties if made before five years have passed or before age 59½.
The Backdoor Roth IRA isn't the only tool in your arsenal. Here are a few complementary strategies to optimize your retirement savings:
Mega Backdoor Roth IRA – If your 401(k) plan allows for after-tax contributions, you may be eligible for a Mega Backdoor Roth strategy.
Charitable Giving – Strategic donations can reduce your MAGI and improve your overall tax picture.
The Backdoor Roth IRA is a game-changer for high-net-worth households seeking long-term, tax-free growth. When used thoughtfully, it opens doors to significant retirement benefits originally designed for middle-income earners.
This story was produced by Range and reviewed and distributed by Stacker.