What Is a Backdoor Roth IRA? (And Why it Might Benefit High-Income Earners)

By The Galecki Financial Management Team

Anyone who asks the question “What is a backdoor Roth IRA?” usually gets an answer that sparks additional questions about how it works and why it’s so beneficial.

In this concise article, we provide a simple definition, a straightforward explanation of its features, and an honest evaluation of why it’s so pivotal for decreasing high-income earners’ tax liability.

Let’s get started!

Backdoor Roth IRA Explained

Put simply, a backdoor Roth IRA is a strategy—rather than an official type of IRA—that allows high-earners to fund a Roth IRA even when their income exceeds the IRS contribution limits. It’s called a “backdoor” Roth IRA because you put money into a traditional IRA with funds you have already paid taxes on, and then transfer those funds into a Roth IRA.

Take a look at these streamlined feature definitions:

• Roth IRA tax benefits 
  1. Tax-free growth of your money
  2. Tax-free qualified withdrawals
  3. No required minimum distributions (RMDs)
• Eligibility for Roth IRA: Adjusted annually and based on your Modified Adjusted Gross Income (MAGI), these are the income limits for 2024 Roth IRA (full contribution) eligibility:
  1. Single filers: MAGI must be less than $146,000.
  2. Married filing jointly: Combined MAGI must be less than $230,000.
  3. Married filing separately: MAGI must be less than $10,000.
• Contribution limits and deadlines: In 2024, the annual contribution limit for Roth IRAs is $7,000 for those under 50, and $8,000 for those 50 and above. Generally, the deadline is April 15th to make a Roth IRA contribution for the previous tax year.
• Significance of the backdoor Roth IRA for tax-free growth: For high-earners who aren’t allowed to make direct contributions to a Roth IRA because their income exceeds the IRS income limits, the backdoor Roth IRA strategy is crucial for tax-free growth in retirement funds. 
• Accumulating retirement savings over time: By allowing tax-free growth on your current contributions and their future earnings, you can greatly increase the long-term value of your retirement savings.
• Exemption from required minimum distributions (RMDs): One of the key benefits of using a backdoor Roth IRA for retirement savings is that you’re not required to withdraw a minimum amount of money from your account each year.
• Estate planning benefits: While not specifically designed for estate planning, the backdoor Roth IRA’s tax-free growth and withdrawal benefits along with the ability to avoid RMDs can contribute significantly to your estate-planning strategy.
• Step-by-step process for implementing a Backdoor Roth IRA
  1. Open a traditional IRA account. All IRAs must have a starting balance of $0. 
  2. Make a non-deductible contribution.
  3. Wait at least 24 hours before converting funds to a Roth IRA.
  4. Convert the contribution amount to the Roth IRA.
  5. Notify your tax preparer that you’ve utilized this strategy. 

Factors to Consider

In addition to all the benefits of a backdoor Roth IRA, there are consequences you should consider:

• Because of the IRS’s pro rata rule, when you convert funds from a traditional IRA to a Roth IRA using the backdoor method, the source of the converted funds will dictate their tax treatment. Simply put, make sure all IRAs have a starting balance of $0 to fully utilize the benefit of the backdoor Roth IRA strategy. If IRA balances are not at $0, work with your trusted Fee-Only financial planner to explore your options. 
• The “mega” backdoor Roth IRA strategy is similar—but more complex—to the backdoor Roth IRA strategy discussed in this article. Contribution methods and limits, tax implications, and eligibility have unique requirements.
• Starting on January 1st of the tax year in which you make your first-ever Roth IRA contribution (including conversions), a 5-year clock starts ticking. And since a conversion from a traditional IRA to a Roth IRA is considered a separate contribution, you might have to wait five years for earnings in between each conversion to be eligible for a penalty-free withdrawal.

Get in Touch

Backdoor Roth IRAs can be complicated. The tax implications, eligibility requirements, and contribution limits alone can be hard to understand. Now add estate planning, IRS rules, and contribution timeline intricacies and seeking professional help becomes a necessity. 

At Galecki Financial Management, we take pride in being able to provide a comprehensive suite of worry-free wealth management services to our clients. Our team of fee-only fiduciary advisors has the knowledge and experience to skillfully guide you toward your financial goals.

If you’d like to know more, we invite you to schedule a meeting by calling (260) 436-8525 or emailing [email protected]. 

About Galecki Financial Management

At Galecki Financial Management, we help individuals and families confidently pursue their financial goals. We’re anything but a business-as-usual wealth management firm. We’re different. Friendly. Casual. And really good listeners. Indeed, that’s a big part of what makes us different. Everything we do is based on what we hear from you, because our experienced team of professionals specializes in comprehensive financial planning, cash flow analysis, IRA rollovers, financial services, money management, estate planning, retirement planning, and advising. We help you identify your short- and long-term goals, and then we work together to pursue them. Lastly, and most importantly, we’re fee-only, meaning we’re only compensated for our time. Our only incentive is to help you succeed.