Avoid This Mistake When Funding a Backdoor Roth

What You Need to Know

The strategy allows higher-income taxpayers to fund Roth IRAs indirectly when income limitations would make them ineligible to do so.
The IRS blessed the backdoor Roth as a legitimate option when the 2017 tax reforms were enacted.
Ultimately, clients are responsible for keeping track of the non-deductible contributions made to their IRAs.

The so-called “backdoor Roth IRA” is a powerful tool that allows higher-income taxpayers to fund Roth individual retirement accounts indirectly when income limitations would otherwise prevent them from contributing to a Roth. 

On the surface, the strategy seems simple enough: Fund a traditional IRA and convert those funds to a Roth. However, there are rules that must be followed and complications that must be considered when clients consider executing a backdoor Roth IRA funding strategy. 

While the Internal Revenue Service blessed the strategy as a legitimate option when the 2017 tax reforms were enacted, clients can still get into trouble if they don’t pay close attention to the rules of the game.

Backdoor Roth Strategy: The Basics

Under current law, income restrictions prohibit high-income taxpayers from contributing directly to a Roth account. Only clients who earn less than $240,000 (joint returns) or $161,000 (single filers) in 2024 can contribute directly to a Roth IRA. The ability to fund a Roth starts to phase out for clients earning as little as $146,000 (single) or $230,000 (joint returns)). 

Roth conversions, however, aren’t subject to an annual income limit.

In other words, taxpayers whose income is greater than the annual limits are still permitted to execute a backdoor strategy to fund a Roth via a series of transactions (generating current income tax liability in the process). The client accesses this “backdoor” by first contributing to a traditional IRA and subsequently executing a Roth conversion, paying taxes on the amounts converted. This allows the higher-income client to create a source of tax-free income for the future.

Remember, however, that the client (or a spouse) must also have earned income for the year to contribute to the traditional IRA in the first place. Clients should also be advised that for those who have not yet reached age 59.5, a five-year waiting period will apply before they are entitled to access the converted Roth funds without penalty.