How to Do a Backdoor Roth IRA in 3 Simple Steps

Back in 1997, Congress approved the Roth IRA — an alternative to the Traditional IRA that would let hard-working Americans contribute post-tax earnings so their money could grow tax-free.

But it came with a caveat — Americans earning above a certain amount couldn’t partake.

So they let out a collective sigh and kept contributing to their 401(k)s and Traditional IRAs, dreading the day Uncle Sam would take a quarter of their retirement savings.

Then, with the passing of the Tax Increase Prevention and Reconciliation Act of 2005, Congress quietly opened a “backdoor” that would let high-income earners legally sneak money into a Roth.

So how does this backdoor Roth IRA work? What are the benefits? How do you pull one off, and when is it worth it? Let’s investigate the backdoor Roth IRA.

What Is a Backdoor Roth IRA?

A backdoor Roth is a legal tax loophole that allows high earners to keep contributing to a Roth IRA.

The trick is pretty simple:

1. Contribute money you’ve already paid taxes on to a Traditional IRA
2. Convert the Traditional IRA into a Roth IRA

Sneaking funds in the “backdoor” like this lets you still make the maximum contribution to a Roth — $6,000 in 2022, $6,500 in 2023 — even if your income level technically disqualifies you.

If you haven’t brushed up on your Roth IRA income limits lately, you should know that the maximum contribution you can make starts shrinking at $130,500 and goes to $0 at $144,000.

Check this handy chart from Schwab to see your maximum contribution limit. Naturally, if you make below $130,500, you don’t need to worry about a backdoor.

But if you make above $130,500, you can’t officially contribute the full $6,000. At least not through the front door.

Is a Backdoor Roth IRA Legal?

Before we get ahead of ourselves, yes, backdoor Roth IRAs are 100% legal and legitimate. The IRS didn’t nab Al Capone for a backdoor Roth (it was all that other stuff).

In fact, if you read between the lines on the IRS’s retirement page, you’ll see that they basically say you can do a backdoor without spelling it out. They say that while contributions to a Roth IRA have income limits, conversions to a Roth don’t — wink wink, nudge nudge.

So while the IRS will be the ones holding the back door for you, what they won’t let you do is:

• Contribute more than $6,000 ($6,500 in 2023)
• Avoid paying taxes on the amount you shuffle in the backdoor

Basically, performing a backdoor Roth IRA is like ordering off the kid’s menu when you’re over 13. You’re not getting any extra food or paying any less by doing this — you’re just circumventing a requirement to get something that wasn’t designed for you.

But kids’ menus are loss leaders for restaurants, and similarly, some experts at Vox and Yale say that backdoor Roth IRAs are unethical and should be stopped. Congress is actively trying to close the loophole in the tax code that allows for backdoor Roth IRAs — a loophole they wrote into law in 2005.

Now that we’ve covered the legal and ethical considerations, why should you bother doing one in the first place?

What Are the Benefits of a Backdoor Roth IRA?

The benefits of a backdoor Roth are the same as a regular Roth: tax-free income.

Since Roth contributions (or, in our case, conversions) are taxed upfront, the contributions grow tax-free. And since you’ve already paid Uncle Sam his due, you can withdraw your contributions at any time with no tax or penalty.

A 10% penalty does apply to any earnings you withdraw before age 59 ½.

By contrast, Traditional IRAs are tax-deferred, meaning you’ll pay taxes on earnings and contributions when you withdraw. So with a Traditional IRA, you could be hammered by taxes each year you choose to live off of retirement income.

With Roth contributions being taxed now and Traditional being taxed later, conventional wisdom would state that a Traditional IRA still makes more sense if you plan to be in a lower tax bracket in retirement (e.g. making $180,000 now but only plan to withdraw $160,000 annually in retirement).

However, due to numerous other factors, “a Roth beats a Traditional IRA — pretty much every time,” writes the National Association of Plan Advisors. And in the words of our own Kevin Mercadante, “Just about anyone who understands the benefits of a Roth IRA will want to convert their traditional IRA money to a Roth IRA if they can, but the income tax consequences of the conversion can be significant.”

More on those in a bit. But in short, earners at every income level stand to save big on taxes with a Roth, whether they go in the front door or the back.

Here’s a brief tutorial on how to pull it off.

How To Do a Backdoor Roth IRA

We have a highly detailed feature that goes through a Roth IRA conversion step-by-step.

But here’s the short version: it’s not hard to do, and the primary consideration is that by converting your Traditional IRA funds, you will trigger taxes on contributions and earnings. However, if your Traditional IRA is relatively new, you won’t have many earnings to pay taxes on.

Anyways, here are the three steps involved in pulling off a backdoor Roth IRA:

1. Open a Traditional IRA and Contribute Funds.

Your first step is to open a Traditional IRA and contribute funds to it.

If you already have a Traditional IRA, consider maxing it out (in 2022 that’s $6,000 for single filers under 50, $7,000 for over). Remember that your maximum annual IRA contribution combines your Traditional and Roth amounts, so you can’t put $6,000 in both.

You can open a Traditional IRA through most brokerage platforms. And at this stage, picking out assets isn’t important since you’ll be converting the funds to a separate Roth account anyhow.

Learn how to set up a traditional IRA >>> How to Invest in an IRA

2. Immediately Convert Your Traditional IRA to a Roth IRA.

To preface, you want to convert your Traditional to a Roth ASAP because you don’t want your Traditional IRA to start generating taxable earnings. You want those earnings to grow tax-free, which is why we’re doing the backdoor Roth in the first place.

Now, there are three ways you can convert a Traditional to a Roth:

1. Empty your Traditional IRA, get a check from the trustee institution, and deposit the funds in your Roth. This old-fashioned method is called a rollover and, in most cases, isn’t necessary if Method #2 is an option.
2. Simply ask your trustee institution (e.g. Chase, Schwab, etc.) to do a conversion for you. If you keep the Roth with the same institution, they’ll usually be happy to do this (even if it takes a few days).
3. If you want your Traditional and your Roth to be held by separate institutions, ask whoever holds your Traditional what their process is for conversions to a Roth held by another institution. And, if they’re being difficult, just do a rollover.

3. Rinse and Repeat Each Year (Until the Loophole Closes).

One minor drawback to backdoor Roth IRAs is that they’re tedious. You’ll have to keep doing backdoors every single tax year as long as you earn above the income threshold for direct contributions.

Luckily, most CFPs can do backdoors in their sleep, so it’s not that big of a deal. Nor is it much work on your end. You just have to remember to do it and to fill your Roth coffers before Congress seals the backdoor permanently.

So, all things considered, is a backdoor Roth IRA a no-brainer? Or are there drawbacks to consider?

Backdoor Roth IRA Pros and Cons