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The Roth IRA, Backdoor Roth IRA and Mega Backdoor Roth IRA are oft misunderstood and underutilized retirement savings strategies. In my Roth three-part series this week, I'm going to break down each Roth IRA strategy, who is eligible to use them, and what you need to know when using them.
This article focuses on the Backdoor Roth IRA. If you have an after-tax 401(k), forget the Backdoor Roth and read about the Mega Backdoor Roth instead.
You can find all the articles from the Roth IRA series here.
Who Is The Backdoor Roth IRA Strategy For?
For those who don't qualify to contribute directly to a Roth IRA because income is too high and do not have access to the Mega Backdoor strategy, a standard Backdoor Roth is the next step. The Backdoor Roth strategy can be useful to increase your tax-advantaged retirement contributions using personal IRA accounts. The contribution limit is the same as regular Roth contributions.
Remember that Traditional and Roth IRAs share the same contribution limit, and it is a combined limit. Therefore, you cannot contribute both to a Roth IRA and carry out a Backdoor Roth in the same year in an effort to make additional contributions. It doesn't work that way. If you qualify for regular Roth IRA contributions, make them and be done with it (if it's right for you, talk to your advisor first). If you don't qualify for regular Roth IRA contributions, that's when the Backdoor Roth becomes helpful.
How Does The Backdoor Roth IRA Work?
There are four main steps to carry out this strategy as follows:
Open a Traditional IRA if you don't already have one
Contribute post-tax funds (cash)
Immediately roll contributions over to a Roth IRA (before investing it)
Invest funds within the Roth IRA
Leave it alone and let it grow.
These steps effectively complete a Backdoor Roth IRA strategy. The due date is the same as a standard IRA route, which is tax day, so you have until April 2024 to fund your 2023 IRA, and so on.
Makes Sense. What Else Should I Know?
The above simple steps also assume no current Traditional (pre-tax) IRA dollars, which would create pro rata taxation.
Also, come tax season you'll need to file IRS Form 8606 to declare your non-deductible Traditional IRA contributions. In case this doesn't come up naturally with your tax preparer or tax preparation software, you can bookmark this Investopedia article with the step-by-step instructions for filing Form 8606.
To learn more about the Backdoor Roth IRA, I like this NerdWallet article on the strategy. It can be just as helpful to know what not to do, so here's an article from the White Coat Investor that outlines some important Don’ts for Backdoors. I’m here for any questions you still have after reading.
In Summary
The Backdoor Roth is a really helpful workaround to maximize tax advantaged retirement savings. It's still important to be aware that it is not in everyone's best interest to use one even if they are able to, either at all, or perhaps because there are other aspects of their financial situation that should be prioritized over Roth IRA contributions.
This article is intended as financial education, not advice. Planning for Backdoor Roth IRAs is a nuanced situation, so make sure to speak to your advisor before making any changes to your retirement plan or other part of your personal financial plan.
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