Backdoor Roth IRA Contributions
Many higher-income earners are not eligible to contribute directly to a Roth IRA under the current income limits. For 2023, married couples with modified adjusted gross income (MAGI) of more than $228,000 (or $153,000 for individuals) are not allowed to contribute directly to a Roth IRA,1 but they may be able to contribute indirectly using a backdoor Roth IRA contribution.
HOW IT WORKS
Step 1. Make a Non-Deductible Contribution to a Traditional IRA
Regardless of how high your income is, as long as you have earned income, you can make a nondeductible contribution to a traditional IRA. For 2023, the maximum annual contribution limit is $6,500, plus an additional $1,000 in catch-up contributions if you are 50 or older.2
Step 2. Convert Your Contribution to a Roth IRA
Since you made a nondeductible contribution to your traditional IRA, it can be converted to a Roth IRA without triggering any additional taxes. Note that if you have pre-tax money in any other IRAs, part of the Roth conversion amount could be taxable due to the pro-rata rule—see below for details.
Beware the pro-rata rule
The pro-rata rule states that when an individual has multiple IRAs, including all traditional IRAs, SEP-IRAs and SIMPLE IRAs, they will all be treated as one account when determining the tax consequences of any distributions (including Roth conversions).3 That’s why if you have any pre-tax money in these retirement accounts, it could cause part of your Roth conversion to be taxable. It’s important to note that the IRS applies the pro-rata rule to your total IRA balance at the end of the year, not at the time of conversion.4
The timing between contribution and conversion is also important. Due to the pro-rata rule, any earnings on the nondeductible contribution you made to your traditional IRA could be taxable upon conversion.5 Doing the conversion immediately after you make the contribution can help minimize this risk.
Here’s an example
John is 60 years old and would like to contribute the maximum amount to his Roth IRA, but he is not eligible because he earned more than $200,000 in 2023 and exceeds the income limit for Roth contributions. Instead, he creates a backdoor Roth IRA contribution by making a nondeductible contribution of $7,500 to his traditional IRA and then immediately converting that money to his Roth IRA. Assuming he doesn’t have any pre-tax money in any other IRAs, this conversion will not trigger any additional taxes. However, if John had another traditional IRA with $22,500 of pre-tax money in it, then 75% of his conversion amount (or $5,625) would be taxed as ordinary income.
Backdoor Roth contributions can be helpful for high-income households. Speak with your wealth advisor to understand whether this strategy makes sense for your personal situation and for guidance on how to implement it successfully.
1 https://www.irs.gov/retirement-plans/amount-of-roth-ira-contributions-that-you-can-make-for-2023
2 https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits
3 https://advancedretirementstrategies.com/what-the-pro-rata-rule-means-for-your-backdoor-roth-ira
4 https://rodgers-associates.com/blog/pro-rata-rule
5 https://www.investopedia.com/articles/pf/12/roth-ira.asp
ABOUT THE AUTHOR
Hope Carlson, CFP®, CAP®
Hope is a Partner, Wealth Advisor in our San Diego office. She joined legacy firm Dowling & Yahnke in 2017. She is a CERTIFIED FINANCIAL PLANNER™ professional and holds the Chartered Advisor in Philanthropy (CAP®) designation.
Prior to Dowling & Yahnke, Hope spent six years as the chief development officer at the Museum of Us, overseeing fundraising and marketing. She also served as the interim executive director for the San Diego Civic Youth Ballet in Balboa Park and for four years as a strategy consultant with the Boston Consulting Group.
Hope holds a Master of Business Administration (MBA) from Harvard Business School, where she was a Baker Scholar, graduating in the top 5% of her class. She also obtained her Master of Music in Vocal Performance and Literature from the Eastman School of Music and a Bachelor of Arts in Economics with Highest Distinction from the University of Virginia.
Trained as an opera singer, Hope is passionate about music and the arts. She lives in La Jolla with her husband and two daughters.
Timothy Lee, CFP®
Tim joined legacy firm Dowling & Yahnke in 2019 and designs customized personal financial plans. Prior to joining Dowling & Yahnke, he served as a Client Support Specialist at eMoney Advisor and completed internships with two local investment management firms in San Diego.
Tim has earned the CERTIFIED FINANCIAL PLANNER™ certification. He received his undergraduate degree in Economics from the University of California, San Diego. Originally from Torrance, CA, Tim currently resides in Rancho Peñasquitos.