Even if you earn more, it shouldn’t limit your options for retirement planning. There are currently viable options for any American who wishes to make a backdoor Roth contribution.
The backdoor Roth IRA could be the legal solution for high-income earners who are looking to build their retirement wealth.
You can use this strategy to avoid the IRS income limits, and enjoy the benefits of Roth accounts in the long term. These include tax-free withdrawals as well as no required minimum distributions.
Discover what a backdoor Roth IRA is, how it functions, and why you may want to consider it as part of your retirement plan.
The backdoor Roth IRA allows you to enjoy tax-free withdrawals and growth from your retirement savings. It does this by converting the after-tax contributions of a traditional IRA. This is a good strategy for those who earn a lot of money and want to enjoy long-term tax benefits, flexible withdrawals and an efficient wealth transfer.
You can boost your savings by using a backdoor Roth IRA if your 401(k)allows it. If you take into account the pro-rata rule, relevant timing restrictions this can be a very powerful part of your retirement strategy and tax plan, especially if you have expert guidance.
What is a Backdoor Roth IRA?
Backdoor Roth IRAs are a way to enjoy the Roth IRA benefits even if your income is higher than the IRS limit for direct contributions.
Normally, if you earn more than a certain amount, you can’t contribute directly to a Roth IRA. The backdoor method offers a way around this: first, you invest in a traditional IRA and then convert those funds into a Roth IRA. Simple concept with powerful results.
The IRS limits direct Roth contributions to higher-earners, but does not cap the income limit for Roth conversions or traditional IRA contributions. You’re still following the rules but you are playing smarter. A backdoor Roth IRA option is legal and IRS approved.
Backdoor Roth IRAs allow you to enjoy tax-free growth and tax-free qualified withdrawals (once you’re 59½ and the account is at least five years old), and penalty-free access to your contributions at any time.
It’s a smart and strategic move, which doesn’t penalize you for your financial success. You can build your retirement wealth at your own pace.
The Backdoor Roth IRA Process
It’s not difficult to set up a backdoor Roth IRA, but you need to be careful so as not to make costly mistakes. You can do it in just three simple steps. There’s also an advanced option for those who want to supercharge their savings.
Step 1: Contribute a traditional IRA
You’ll first need a traditional IRA. Open an account at your favorite brokerage or custodian if you do not have one.
The contribution limits will remain the same in 2025 as they were in 2024.
- Up to $7,000 if you are under 50
- Up to $8,000 if your age is 50 and older
Contribute non-deductible, as your income is likely to disqualify you from claiming a deduction. Think of this as setting the stage for your Roth conversion.
Step 2: Convert to a Roth IRA
Convert it to a Roth IRA once your contribution is in place. This is usually done through the online dashboard of most brokerages. You can choose to convert the entire amount or a small portion depending on your strategy.
Tip: Convert it as soon as you can. The longer you leave your contribution in the traditional IRA the greater the chance that it will earn income. This could lead to a tax bill when you decide to convert.
Consult a financial planner or retirement planning service if you are unsure of the tax implications and timing.
Step 3: Be aware of the pro-rata rule
This is where it gets tricky. To calculate the tax due on your conversion, the IRS uses a pro-rata formula. The IRS looks at all of your pre-tax and after-tax money in traditional IRAs, not just the one that you are converting.
Imagine you have $100,000 in traditional IRAs, $90,000 before tax and $10,000 after tax. Only 10% of the $10,000 will be tax free if you convert it. The remaining 90% of the amount will be taxed as income.
The takeaway? Even seasoned investors can be surprised by the pro-rata rule. Consider rolling over or cleaning up pre-tax IRA balances before converting a backdoor Roth IRA.
Bonus strategy: The Mega Backdoor Roth-IRA
Want to go bigger? The mega backdoor Roth IRA is a powerful 401 (k) strategy that allows you to contribute up to $70,000 in 2025 (or $77,500 if you’re 50 or older).
How it works
- You must be enrolled in a 401(k) plan that allows contributions after tax (not all do, check with your HR department).
- Your plan must also permit in-service distributions to a Roth IRA or Roth 401(k).
This is a great strategy if you’ve already maxed-out other tax-advantaged accounts and wish to even further increase your retirement savings.
Ask yourself these questions before you dive in:
- Does my 401(k) plan allow it?
- What am I saving already?
- What are my financial goals, both short and long term?
- Will this bump me up to a higher tax bracket for this year.
The mega backdoor Roth is a great way to build tax-efficient wealth, If the answer supports your broader financial plan.
Backdoor Roth IRA Benefits
The backdoor Roth IRA offers long-term benefits that traditional retirement plans simply cannot match.
1. Tax-free withdrawals for qualified distributions
The biggest perk?Tax-free growth and withdrawals
While traditional IRAs grow tax-deferred and hit you with income tax upon withdrawal, Roth IRAs let your money grow tax-free and allow you to take it out tax-free in retirement if you meet the requirements: you’re at least 59½ and the account is at least five years old. That means you’re keeping more of what you’ve earned and letting compound interest work harder for you.
2. No Required Minimum Distributions (RMDs).
Traditional IRAs require you to begin withdrawing money at age 73 regardless of whether you actually need it or not. These withdrawals will be taxed as income, which could put you in a higher bracket of taxation and affect your Medicare premiums.
Roth IRAs? No RMDs during your lifetime. This gives you greater flexibility in deciding when to access your funds.
3. Strategic timing with low-income-year conversions
Roth conversions are a good idea if you expect to have a temporary drop in income. For example, if you plan on selling your business, taking a sabbatical or retiring early.
Why? You’ll be in a lower bracket of tax and converting during those years will reduce your total tax liability. The backdoor Roth is not only a way to make contributions, but it’s also a strategic tax-planning asset.
4. Tax-free inheritance is an efficient way to transfer wealth.
Roth IRAs are also a great way to pass wealth on to heirs. It allows beneficiaries to receive their assets tax-free. This is unlike traditional IRAs that often burden heirs with unexpected taxes.
Because there are no RMDs for you, you can preserve more of your wealth, allowing your assets to continue growing and transfer more efficiently to the next generation.
Contrary to traditional IRAs that delay taxes, but eventually incur a tax liability, the backdoor Roth IRA lets you pay taxes at your own pace and never again. This combines flexibility, efficiency and long-term impacts for high earners.
Get Your Money Controlled Smarter Way
Backdoor Roth IRAs are a powerful tool that can complement your status as a high-income earner. It reduces future taxes, diversifies retirement income and creates wealth for the long-term. It is a crucial component of any comprehensive long-term financial plan.
Are you ready to make it work? Parr & Ibarra CPA in Keller, Texas is here to guide you with confidence and clarity through each step!
