Is A Backdoor Roth IRA A Good Move For Higher Income Earners?

There are three primary types of retirement plans in the U.S. today: Traditional IRAs, 401(k)s, and Roth IRAs. This article will focus on whether doing a backdoor Roth IRA is a good move for higher income earners.

It is often debated which of the two IRA options is better: the Traditional IRA that is tax deferred, or the Roth IRA that is funded after tax. Hypothetically speaking, if your earnings and tax rates went unchanged for your entire life, both types of IRA plans would net you the same amount of money in the end – it’d just be a matter of either paying the taxes up front or deferring them until later.

However, it’s unlikely you’d actually be in a situation where those two variables would stay constant for your entire lifetime, since earnings and income tax rates regularly fluctuate.

I've been a staunch opponent of the Roth IRA because it's never a good idea to pay taxes up front to a government who excels at wasting money. So long as you have your money, you can figure out ways to shelter your money from the government in a myriad of legal ways.

But what if you are a super pessimist who believes taxes have to go up because the budget is so poorly managed? Furthermore, you're inept at navigating the many legal tax savings rules. In such a scenario, even those of us in the lowly 25% and under federal income tax brackets are probably not safe.

U.S. Budget Deficit Continues To Grow

The future of U.S. debt

The study shows that the government is bound to continue outspending its revenues, which sadly isn’t a surprise. With this expectation, it’s likely that income tax rates will rise to fund such deficit spending. And, if tax rates are projected to increase, paying taxes now could be beneficial if you plan on working and earning an increasing income for a long time.

If tax rates are higher by the time you retire, you could avoid paying more taxes by putting money in a Roth IRA now and enjoying tax-free withdrawals in your retirement years. Since Roth IRAs are funded with after tax money, you’re using whatever income tax rate you have when you contribute to the account, and your money will also grow tax-free over the years.

While the Roth IRA may be one’s retirement account of choice, higher income earners are prohibited from investing their money in this plan. According to IRS rules for Roth IRA plans in 2021, single individuals with a MAGI (modified adjusted growth income) of over $140,000 and couples with a MAGI over $208,000 may not contribute directly into a Roth IRA to benefit from the tax breaks.

Only individuals who earn $125,000 or less and married couples who earn $198,000 or less can contribute the full $6,000 to their Roth IRA for 2021.

Roth IRA Contribution And Income Limit 2021
[Roth IRA Contribution And Income Limit 2021]

A MAGI of $208,000 for a couple living in places like San Francisco, Los Angeles, and New York is squarely middle class. It's so strange the IRS has such a low income limit for a Roth IRA contribution, and doesn't adjust for various cost of living locations.

Good thing there's the backdoor Roth IRA.

The Backdoor Roth IRA

The way that higher income folks are able to contribute to Roth IRAs has been dubbed the “backdoor Roth IRA” strategy, and as of now it’s totally legitimate. In the past however, it didn’t exist.

Up until 2010, there were wealth restrictions on both direct Roth IRA contributions and conversions from other retirement accounts. But the restrictions on conversions was lifted, and now one can contribute non-deferred funds to a traditional IRA, and then simply convert those funds into a Roth IRA each year.

If you’re over the income limits to contribute directly to a Roth IRA, here are the basic steps you can take in order to fully fund a Roth IRA through the backdoor:

  1. Open a Traditional IRA and fully fund it with $6,000 in after tax dollars (without a deduction). That may sound strange since Traditional IRAs are normally funded with pre-tax dollars, but this is how it’s done if you’re a high-income earner. If you’re over 50 years old, you can contribute an additional $1,000.
  2. Next, contact your plan administrator and have them transfer those funds out of the Traditional IRA and into to a Roth IRA. This can usually be done in just a matter of minutes, but the processing speed may differ based on your service provider.
  3. Just note that if you don't convert to a Roth IRA right away and you have some gains, you'll have to pay taxes on those gains. Hence, the simplest way is to convert immediately. You can apparently do a backdoor Roth IRA every single year.

Sounds pretty easy right? Double check if your plan administrator offers this option of converting Traditional IRAs to Roth accounts. Most providers offer this service, but yours may not, plus they may charge a fee to convert your account. So double check first.

If you have other Traditional IRA accounts, things can be a bit more complicated with taxes if you go to convert, but it can still be done. A pro rata rule comes into play if you have money in any deducible IRAs, and taxes would be due at conversion on the pro rated amounts of the conversion that were deducible.

For example,if you have a traditional IRA with $95,000 of money from a 401(k) rollover (the $95,000 contributions were made on a pre-tax basis), and you make a $5,000 nondeductible contribution to a new IRA, the conversion would be 95% taxable. Best to check with your accountant if you fall into this type of scenario as they can advise if you’re better off converting or not based on how the potential taxes due would shake out.

All in all, the backdoor Roth IRA conversion process is pretty simple and your plan administrator will let you know what forms you have to fill out or if you can simply log into your account and do it online. If you convert your account within the brokerage firm, that simplifies the process even more versus having to transfer money to an entirely new account with a different company.

Roth IRA Withdrawal Guidelines

The Roth IRA provides retirement liquidity diversification if you ever need the money sooner. Here are the following withdrawal guidelines.

If you are age 59 and under:

You can withdraw contributions (not backdoor conversions) you made to your Roth IRA anytime, tax- and penalty-free. However, you may have to pay taxes and penalties on earnings in your Roth IRA.

Withdrawals from a Roth IRA you've had less than five years.

If you take a distribution of Roth IRA earnings before you reach age 59½ and before the account is five years old, the earnings may be subject to taxes and penalties. You may be able to avoid penalties (but not taxes) in the following situations:

  • You use the withdrawal (up to a $10,000 lifetime maximum) to pay for a first-time home purchase.
  • You use the withdrawal to pay for qualified education expenses.
  • You're at least age 59½.
  • You become disabled or pass away.
  • You use the withdrawal to pay for unreimbursed medical expenses or health insurance if you’re unemployed.
  • The distribution is made in substantially equal periodic payments.

Withdrawals from a Roth IRA you've had more than five years.

If you’re under age 59½ and your Roth IRA has been open five years or more, your earnings will not be subject to taxes if you meet one of the following conditions:

  • You use the withdrawal (up to a $10,000 lifetime maximum) to pay for a first-time home purchase.
  • You use the withdrawal to pay for qualified education expenses.
  • You're at least age 59½.
  • You become disabled or pass away.
  • You use the withdrawal to pay for unreimbursed medical expenses or health insurance if you’re unemployed.
  • The distribution is made in substantially equal periodic payments.

All sounds reasonable right? Unfortunately for a backdoor Roth, there may be a 10% early withdrawal penalty if you need to withdraw your money in the next five years and you're still under 59.5 years old since the IRS doesn't view the backdoor Roth as an actual contribution. Finally, if you happen to be 70 ½ or older, sorry you don’t qualify. It's time to live it up already!

Is The Backdoor Roth IRA Worth The Hassle?

While it’s pretty straightforward to create a backdoor Roth, is it really worth the hassle? $6,000 a year in extra saving isn't exactly going to make you rich. But if you've maxed out your 401k, are saving even more in after-tax accounts, have extra liquidity to spare, are still in the 24% single or joint federal income tax bracket, and bullish about your income growth, then a backdoor Roth is a reasonable move for retirement diversification purposes.

We are at the historical bottom end of the income tax rate range after the Trump tax reform bill was passed in 2018. It is more than likely income tax rates will go up after 2025, when the tax reform bill sets to expire. Further, your income will likely continue to rise, perhaps to a point where it eventually precludes you from contributing to a Roth IRA.

You never exactly know your cash flow needs in retirement. Therefore, if you have the ability to contribute to a Roth IRA and conduct a backdoor Roth IRA, you might as well do it. You can open one up with Betterment, one of the leading digital wealth advisors with a few clicks of the button.

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Updated for 2021 and beyond.

68 thoughts on “Is A Backdoor Roth IRA A Good Move For Higher Income Earners?”

  1. Is it worth it to do a backdoor IRA if you are married and both in the 35% income bracket? But you’ve maxed our on your 401K and bullish about our income.

  2. Hi Sam, cam across this article and found it to be an interesting read. Then I almost had a heart attack reading a comment about the “Step Doctrine”. I made a silly mistake with my taxes about two years ago which resulted in removing a Roth contribution and ended up paying the excise tax on my and my wife’s Roth contributions which was about $900. They even “wisely” call it an excise tax so that the first time abatement program only offers a small amount of relief for those who make the mistake of an ineligible contribution. Anyway, I did further research on the Step Doctrine and discovered that the Tax Cuts and Jobs Act signed by President Trump in 2017 appears to have made it legal..or at the very least, given people a fighting chance if ever confronted by the IRS. I’ll be curious to hear how it plays out if the IRS decides to go rogue! Great work on this blog by the way…really enjoying it!

  3. Late to the game here…

    For those who are maxing out their pre-tax contributions ($36k for couple) and want to take advantage of retirement tax advantages, isn’t the backdoor roth contribution a no-brainer? While it limits you to waiting until retirement age to withdrawal the earnings, you will never pay taxes on those earnings. So if your whole premise is to save taxes in retirement and you can stand to wait, you can save significant funds by doing this rather than putting that $11k ($5,500 each) into a brokerage account.

    As a 29 year old with at least 33 years to go, if we contribute $11k each year at a 7% return rate, I calculate that we will save $220k+ in taxes on those earnings by going through a backdoor roth…

  4. Hey Sam,

    I make too little and can contribute the max to a Roth IRA. However, I make too much to contribute 18k to my 401k due to nondiscrimination testing. It upsets me that I get limited and then have to pay taxes on a large sum taken out of my retirement account. Any way around that? Haven’t seen that discussed before but that’s probably because your readers are mostly business owners and not employees.

    1. If your 401(k) plan allows non-Roth after-tax contributions, you can roll those contributions over into your Roth IRA. People are calling this method the mega backdoor Roth. Look it up on Google. Hope this helps!

      I too am limited to less than 18k for my 401(k) but can contribute more via the aforementioned method.

  5. I’d heard about this briefly before but never really understood it until now. Thanks for such a helpful article. Makes me wonder how long the IRS will keep the backdoor open. :)

  6. Some food for thought: My husband and I spoke to an estate attorney about the backdoor Roth. He believed the timing of the conversion needs to happen such that the step doctrine is not flagged. 6 months was his recommendation, but he didn’t think it was worth it for $5500.

    Also, another method of dodging the pro-rata rule is to open a solo 401K if you happen to have a 2nd job unrelated to your 1st job. You can roll your existing non-deductible IRA into that 401K and then proceed with the steps above.

  7. Sam,

    I read your blog evey so often, but I think you’re confused about the benefits of the two different types of IRA’s(and I think all this is due to the fact that you earn way much more than most Americans). You say:

    “Hypothetically speaking, if your earnings and tax rates went unchanged for your entire life, both types of IRA plans would net you the same amount of money in the end.”

    That is wrong on many levels. If you’re making 60K a year and you are on the 25% MARGINAL tax bracket you’re probably paying about a 15% EFFECTIVE tax rate. If you invest in a traditional IRA you won’t be paying 25% on whatever you save and then when you retire and you’re earning 60K in retirement(coming exclusively from traditional accounts) you’d only be paying ~15% tax on the money because the first couple of K’s are taxed way less than 25%.

    1. If you had invested the money in Roth accounts, you’d be paying 25% taxes all along.

      When I started my career as an engineer and was earning 50K a year, I’d invest on traditional accounts until I pulled myself down to the 15% tax bracket and then I’d invest in roth accounts. The plan is then in retirement I’ll pull money from the traditional accounts first and then when I get to a marginal tax rate higher than 15% , I’ll pull whatever additional money from my roth accounts(for which I only paid 15%) so I’d be paying less taxes for my traditional investments and for my Roth investments. Of course all this can change if tax rates change in the future… But diversifieng when it comes to types of accounts can have its benefits.

      1. Emmanuel,
        That’s exactly how I view my Roth–a way to cap taxes in retirement. What I would not want to happen is for some big expense: trip-of-a-lifetime, Grandchildren’s college, big medical expense, etc. to end up dragging me up a tax bracket.

        I do need to dig deeper into required minimum withdrawals, though. I think they could be a spoiler: I don’t want to be so brilliant in balancing my tax bill early in my retirement, that I end up racing into high brackets after RMD’s kick in.

  8. “If you’re in the 35% federal income tax bracket or higher, I wouldn’t bother. You’re already getting fleeced!”

    I don’t necessarily agree. The backdoor Roth is still a good forced savings tool. And if you have kids that will likely go to college, it offers far more flexibility than a 529. The way I look at it: it forces me to put away an additional 11k a year that I can use to pay for kids’ college and then my wife and I will whatever gains are generated from that principal (and compounded on the gains) in retirement. If my kids get scholarships, or I’m in a financial situation where it appears it’ll be virtually impossible for me to retire one day without the Roth principal (hopefully the latter never happens, but people experience all sorts of reversals) then I’ll have the money for retirement.

    1. Another benefit is that some colleges will factor 529 plan money into the financial aid equation but not money in parents’ retirement accounts like IRAs and 401(k)s.

  9. I like the backdoor roth as a way to protect a little bit of money each year. What I like most about 401ks and IRAs is that they are bankruptcy proof and judgment proof, meaning if you ever get sued, your judgment creditor cannot get to your retirement assets – for a 401k, there is no ceiling because you’re protected by ERISA; for an IRA, you’re in state law territory, but I think in most states you’re protected up to $1m. Since I’m a regular W-2 employee, it works for me because I can dump an additional $5.5k per year into a “safe place.” I make too much money to qualify for a regular roth IRA, so I’ve done the backdoor strategy for the past two years (if you’re paying taxes upfront anyway, it’s kind of a no brainer).

    Also, you have more flexibility with an IRA than people realize. For example, I know of someone who needed to do a reverse 1031 exchange and used a loan from his roth IRA to buy the new “replacement” property (you can do that for up to 60 days) and when the old “relinquish” property sold, he was able to pay off the roth IRA loan. The benefit of taking a loan from your roth IRA over a regular IRA loan is that if you screw up and can’t pay off the loan in time, you only have to pay taxes on your investment gain (no taxes on the original earnings or 10% penalty).

    1. Great reminder on 401ks and IRAs being bankruptcy/judgement proof! I hope nobody ever goes through the process, but this is definitely a good moral hazard win for us risk takers or unfortunate souls!

      1. Yes, but I did make one stupid mistake in my hurried comment. There is a 10% penalty even on a Roth IRA if you take a 60-day loan then don’t pay it back in 60 days. The IRS treats it like a regular withdrawal, so you’re playing with fire when you borrow from an IRA like that. But there are circumstances where the risk is justified.

        1. To borrow from an IRA to buy property; dont you need it to be a self directed IRA with only certain providers? Might be a good blog post topic

  10. Curious to know your list of legal tax shelters that are possible after maxing out 401k, HSA, and IRA options. I don’t know of other investments where my income is tax deferred

  11. Stringer Bell

    I’m in the 35% bracket and have been considering the back-door IRA for the sole purpose of housing more speculative investments. It’s a nominal amount for me, but the ability to defer short-term capital gains until retirement age (while simultaneously redeploying that capital in higher risk/reward scenarios) is appealing considering the large STCG bill I’m facing this year. Sam, would be curious to hear your thoughts.

    1. I wouldn’t waste my time at the 35% tax bracket. Keep your money for as long as possible!

      Spend time starting a side business instead. Lots more tax advantages that way.

  12. We are a dual retired military couple.

    Our traditional retirement accounts are our smallest bucket (due to the TSP not becoming available to military until late in our careers — we both maxed out when it did open up to us)

    Next, come our Roth accounts bucket. I am a big fan. The TSP came along in time for us to keep below the income limits for a few years, and once we made to much we made non-deductible traditional IRA contributions in a basic savings account and waited until the 2010 tax law changes that allowed us to convert and then we invested that amount into the market. After that, we did backdoor contributions as long as we had the earned income to do it.

    Our biggest bucket by far is in taxable accounts — we spent most of our careers with very little tax advantage space, so taxable, it was! So, every year we get taxed on dividends, even though at a lower rate since they are mostly qualified.

    But, even though we haven’t hit that magical 59 1/2 ; which would give us unfettered access to the Roth accounts, they have added a great deal to our sense of financial security, not to mention future tax flexibility. And, quite frankly it is fun to watch this bucket grow, knowing there is no current or future tax burden on it.

    My aunt took $10k out of her roth last tax year to go on an extra splurge vacation, and was happy to not have to pay taxes on it! This is one way my DH and I plan to utilize ours in the future.

    1. What about your pension? As a dual military couple, surely you’ve got a great pension for life and are just laughing at us commoners who must figure out the retirement landscape ourselves? :)

      Thanks for your service.

  13. My main purpose of converting as much to a Roth IRA is to lower my RMD at 70.5. Since we roll my husband pension to an IRA and my 401k.

  14. There is no penalty for doing a Roth IRA (or backdoor Roth IRA) for high earners who are ineligible for a deductible traditional IRA.

    You have to pay taxes on any money you earn unless you have a tax deduction. People whose income prohibits them from contributing to a deductible traditional IRA have already paid the taxes on the money they earned. Putting money in a Roth IRA simply allows these people to grow their money tax free from this point forward. As such, these high earners are not paying more in tax by opting for the Roth because the deductible IRA was never an option for them.

    1. Thanks $iddhartha. That’s what I thought — and why I’m curious to hear Sam’s reasons against.

    2. I agree. I’ve read Sam’s posts talking about how we shouldn’t be giving the gov’t more money and should avoid paying taxes which are seemingly targeted towards people who are eligible for a deductible IRA contribution but choose to do a Roth. I agree with this, which is why I max out my 401k with pre-tax and not Roth. The real question is what to do if you make too much money for pre-tax. Is a $5.5k Backdoor Roth, and potentially many multiples of that for Mega Backdoor Roth better than using excess funds for other things. The only better use I can think of would be for real estate investing in a stable market where you can make money renting it out, or during a crash in a market like SF. Otherwise, you’re either letting it sit cash or doing investing in a brokerage account. Seems to me like a Roth would be better than that.

  15. My question pertains to your thoughts on when it makes sense to use Mega Backdoor Roth to get the account up to or approach $53k/yr.

    I am 33 and make about $150k/yr and will probably continuing making about that amount adjusted for COLA/Inflation for the rest of my career. I am currently single, although it is possible I may have a spouse in the future that adds some amount of income, maybe a lot. Ever since I was 22, I have been maxing out my 401k pre-tax (except for a 2year break for a MBA) and Roth IRA (including via backdoor once that loophole opened). Starting this year, I also max out a HSA. I also own a waterfront Condo in SF that’s worth about $500K and has a $321k mortgage. I am in the 28% federal and 9% California marginal brackets.

    After my monthly expenses and maxing out pre-tax 401k, pre-tax HSA and backdoor Roth, and taking account of total yearly taxes with all the deductions, I end up with about $20,000 after-tax increase to my bank account. In the past I’ve used some of this money to slowly pay down student loans (only $19k @6.8% left) or put a down payment on my condo. I’m wondering now if I should take some of this and use it towards Mega Backdoor Roth. I am allowed to put up to $23k/yr into it based on max contribution of $18k and employer match of about $12k.

    If this isn’t a good idea, what else should I do with it? I’m not interested in buying more property until the next real estate crash and can get an interest-free loan from my parents for that when it happens.

    1. Personally, I am maxing out a mega backdoor Roth before exploring other investments. I too max out HSA, Roth IRA, and (non-Roth) 401k. My retirement strategy is solely stock and bonds though. If you have no other plans for the money, then the mega backdoor Roth makes sense.

      As for sources of money down the road (besides parents)… contributions to a Roth can be taken out after 5 years. Also, with my company, 401k loans are an easy user-friendly option.

    2. I would pay off that 6.8% student loan first or any other debt with a higher rate. With the market as high as it is and real estate in San francisco getting pricey its going to be hard to find a better return on your money over the next few years

    3. I’d 1) Pay down that atrocious 6.8% student loan since it’s not that much left, 2) Max out whatever you can contribute (you can even do more if you become a contractor), and 3) Not count on borrowing an interest free loan from your parents, but instead, give them an interest free loan and help them out.

  16. Hi Sam. I’m not sure I understand your last two sentences. As an ‘already getting fleeced’ taxpayer, my Traditional IRA contributions are non-deductible. Plus I will get taxed on any withdrawals when the time comes (presumably at a lower income level than I am at now).

    However, if I contribute to a non-deductible Traditional IRA now, then backdoor convert it to a Roth IRA, as far as I understand it I will only pay tax on any increase between the contribution and conversion (likely to be small) — and in return, I won’t pay ANY taxes on the withdrawals (lower tax bracket or not) and that IRA could be pretty sizeable with investment returns. So why wouldn’t it make sense?

    NB I have a 401k but no rollover IRA (same employer for a long time).

    1. Jeep,

      That is what I do. I fund the 5500.00 per year in a non-deductible IRA and then immediately convert to a Roth IRA. I therefore get all the growth tax free. With the contribution limit so low it doesn’t make a huge difference but the process only takes about 5 minutes. Well worth the time IMO.

    2. Jeep, your interpretation is correct.

      You may also want to investigate whether your company allows you to utilize a method known as a “mega backdoor Roth” if you are looking for the ability to save more.

    3. Thank you, Bill and $iddhartha. I’ve been a bit gun shy on this up until now. Sounds like it’s time to act. And yes, it looks like I can make after-tax non-deductible contributions which can be immediately rolled over. Even better!

      One last question if I may. Reading through my 401k plan documentation, it appears I can make a withdrawal at any time without penalty provided it’s immediately rolled into an IRA (and you have 5+ years tenure). Does that sound right? Seems rather incredible I could get all the money out and into much lower fee funds so easily.

      1. A lot of this depends on your plan’s specific rules. Unfortunately, at this point, many plans don’t make this process very straightforward.

        For most 401k plans, your money falls into one of the following categories.
        1) deductible contributions (plus earnings)
        2) Roth contributions (plus earnings)
        3) Matching contributions (plus earnings)
        4) non-Roth after-tax contributions (plus earnings)
        5) previous money rolled into the 401k plan (plus earnings)

        If you’re under 59-1/2, the plan can’t distribute your pre-tax contributions and earnings when you are still working there. For mega backdoor Roth purposes most people would only want to roll over #4 from above.

        Some plans may allow you to perform this action multiple times per year and some may only let you do it once per year. Just make sure you get someone to send you the tax bill for the conversion so you can pay taxes on the earnings.

        You can also roll over #3 above to a Roth, but if you do that you will owe taxes on 100% of that money because it is money that has not previously been taxed.

  17. Ryan Schaap

    Excellent post about the Roth IRA, particularly alerting people to the potential tax issue if they have a rollover IRA from a 401K or other tax deferred IRA. I tend to be a Roth IRA opponent for many of the same reasons mentioned in this and other posts. However, if you think you will be in the same or a higher tax bracket when retired, another consideration is that the Roth IRA effectively allows you to save more money because the contribution limits for both types of IRA are the same. For example, if your combined state and federal tax rate is 40%, and you save $100,000 in a Roth IRA, you will have $100,000 in retirement after taxes. On the other hand, the after-tax value of $100,000 in a traditional IRA is only $60,000. If you have the ability to pay the tax upfront, you can effectively increase the after-tax savings you have for retirement by using the Roth IRA. The higher the tax rate, the more you can effectively save using a Roth IRA.

    My main problem with the Roth IRA is that with some planning most people will see a reduction in their tax rate after retirement, which makes paying the higher rates now on the Roth contribution more onerous. Of course, this is not the case for everyone.

    This is my first comment, so forgive me if this point has been made elsewhere and I missed it. I’ve really enjoyed the insight given to me in so many of the posts.

    1. Thanks for sharing your thoughts Ryan.

      Here’s the thing, I would say the large majority of people will NOT earn more money in retirement than while they are working. This is a pipe dream where people overestimate their retirement savings and energy/skills abilities.

      Tax rates will be LOWER, all things being equal, in retirement (older people are protected by the gov’t as they are a powerful voting class), given income will be lower.

      1. Absolutely! Although I’ve often thought the Roth could be used as an effective tool to reduce taxable income by limiting what needs to be withdrawn from taxable 401Ks and IRAs. My fear is that in the future the government will not tax Roth withdrawals directly (a political nonstarter), but backdoor a tax like the government does with AMT preference items. As an AMT preference item taxing a Roth withdrawal is just soaking the rich, right? Or am I paranoid?

  18. The one issue that I potentially see with this plan is that if your modified AGI is above the IRA deduction limits, then any contribution that you make to your IRA would not be pre-tax to begin with. Therefore you might as well just contribute directly to a Roth IRA and avoid having to do the whole conversion thing.

    But on another note, if you have an old 401(k) that you convert into a Rollover IRA, then let’s say you decide to retire early. Since you will no longer have an AGI above the IRA deduction limits (since you stopped working) you can then convert your Rollover IRA into a Roth IRA. But I’m pretty sure there’s limits of how much you can roll over before some sort of tax kicks in, if you try rolling over 100k I’m pretty sure the tax man will come knocking.

    1. I’m not sure I understand. If your contributions to a 401k or traditional IRA are tax deferred, in converting over to a Roth IRA, there is no way to avoid paying taxes at that point, right? unless perhaps you have $0 in current year income and are converting over a miniscule amount (whatever would result in a 0% tax bracket)?

      1. Your IRA contributions are tax deferred unless your Adjusted Gross Income (AGI) is over a certain level, here’s a link to the IRS website on that particular item:

        Now this is the part I would need to do more research on since I haven’t tried it yet since I’m not that far in my FI journey. But if you search for “Roth conversion ladder” it will give you some much more detailed articles on how to convert from your IRA to a Roth IRA while avoiding being taxed. The trick is that your AGI needs to be below a certain level to make it work, so for high income earners this doesn’t work, but for early retirees who suddenly no longer work and have a much lower AGI this strategy can work.

  19. I hope this method is not closed for several years. I plan to convert funds once I retire at age 45 over several years while trying to stay in the 0% bracket. That will give me funds maturing each year. I still put some funds in a Roth currently (am just under the limits), but that is as a sort of hedge in case the government goes crazy with tax rates.

    1. Government raised the retirement age for us youngsters to 67 yo. I wouldn’t be surprise if they don’t raise the Roth IRA age from 59 to 62 or 65 in desperate time forcing us to pay taxes if we decide to withdraw :) just saying never say never. Heheheh. I’m not sure if this coming year I’ll be eligible for Roth, I’ve seen some PF bloggers trying to do the conversion. The company I had both Roth and tradition is fragment, I’m not sure they can do this for me cleanly. I want to do it myself.

    2. Got to love a 0% tax bracket! To clarify, is that simply you retiring early and making no money?

      In retrospect, that’s probably what I should have done in 2013 after my 2012 severance package was paid!

  20. Sam,

    Good post! I currently max out my 401k and my wife maxes out her Roth 401k. We are in the 33% tax bracket so I went back and forth on whether we should use a regular 401k for her. I didn’t want to bother with the Backdoor Roth every year so I thought putting 3x as much in the Roth 401k would be better. I went this route to diversify since I’m unsure of what the tax situation will be when we retire. Also I like the fact we can convert the Roth 401k to a Roth IRA and not be required to take distributions at 70, therefore leaving tax free money to our heirs. Do you think it would still be better to switch to an all pretax 401k for both of us and do two Backdoor coversions each year?


    1. I’m all about pre-tax 401k to the max $18,000 for 2015 and every year for both spouses. That’s $36,000+ a year pre-tax plus any company matches. After that’s done, then save an additional 20% in after-tax, after-401k contribution money. Do that for 20+ years and there is no doubt in my mind a couple will be financially set unless some disaster strikes.

  21. For a high-earning and saving couple, I don’t think the normal backdoor roth is worth the hassle. A high earner will likely have other IRA accounts that complicate the process (potentially considerably), and the benefits ($11K per couple) are pretty trivial if you’re already saving > $100K per year anyway.

    Now the mega-backdoor Roth is a different matter entirely. With the potential to save ~$100K per couple if your employer’s 401k plan allows it, that begins to look very interesting.

    But generally, a high-income earner should not be spending time trying to figure out how to get an extra $1K here or there into a Roth IRA. Wasted time.

    1. However, if you like the choices in your 401K plan, and the allow, you can transfer al, of your non Roth IRAs into your 401k plan.

      Then when you do the back door Roth, ther are no taxes. I did this last year prior to doing a back door Roth. Easy Peasy!

  22. Vivek Gupta

    You wrote “Hypothetically speaking, if your earnings and tax rates went unchanged for your entire life, both types of IRA plans would net you the same amount of money in the end – it’d just be a matter of either paying the taxes up front or deferring them until later.”

    Not sure, if that’s the case. In traditional IRA, the amount invested is bigger as tax has not been paid. Interest income would be bigger and hence traditional IRA should net higher amount of money. Am I missing something obvious?

    1. Vivek, as stated if your tax rates stay the same while working vs retirement then Traditional vs Roth makes no difference. Because while you may initially invest more in a traditional that grows, then you have a higher amount that is taxed. I have included some math below to show

      Traditional IRA – $5000 invested each year for 10 years earning 10% a year assuming 25% tax rate

      $5000 invested each year for 10 years earning 10% a year

      Year 1: 5000
      Year 2: 10500
      Year 3: 16550
      Year 4: 23205
      Year 5: 30525.5
      Year 6: 38578.05
      Year 7: 47435.86
      Year 8: 57179.44
      Year 9: 67897.38
      Year 10: 79687.12

      79687.12 * .75 = $59,765.34 after 25% tax

      in a roth ira assuming you are in same 25% bracket it is investing 3750 a year (5000*.75)

      Year 1: 3750
      Year 2: 7875
      Year 3: 12412.5
      Year 4: 17403.75
      Year 5: 22894.13
      Year 6: 28933.54
      Year 7: 35576.89
      Year 8 : 42884.58
      Year 9: 50923.04
      Year 10: 59765.34

      Total roth ira is $59,765.34 because no tax on distributions so they are the same.

      Hope this illustration makes sense.

        1. Keep in mind the drawback with traditional IRAs and 401Ks is that the distributions are counted as income, even if they are held in equities. Capital gains in the current tax environment is most likely lower than your income tax.

          The trivial example is if you bought but never sold equities in a traditional IRA during the life of the IRA, the taxes will actually be higher on the gains than if you just held the stock outright. There a certainly scenarios where traditional IRAs/401Ks are a detriment.

    2. You are missing something obvious. You’ll earn way more in interest and pay way more in raw tax dollars. It’s a complete wash and the math is simple. Say your investment doubles and your tax rate is 25% to make the math simple. Use a $100 investment for illustration.

      Traditional: $100 x 2 = $200 x (1-0.25) = $150.
      You earned $100 investment income, then paid $50 in tax.

      Roth: $100(1-0.25) = $75 x 2 = $150.
      You paid $25 tax, then earned $75 in investment income when your money doubled.

      Main idea: X*Y = Y*X

      1. Vivek has a valid point, that Jacob’s example misses. Yes, if you invest equivalent after-tax amounts, the math is the same ($5,000 traditional, vs. $3,750 Roth) But if you can max out either choice, the Roth is a better shelter, because you can simply shelter more. (in 2015, $5,500 traditional vs. $5,500 Roth) It’s the contribution limits that make a difference; specifically, that they are equal in dollar terms, not after-tax dollar terms.

        I hope I’m not giving some lawmaker ideas…

        1. Matt,

          I was missing the obvious. You are touching a different aspect which was not essentially my question. I understand the aspect that you are highlighting. Thanks for taking out time to comment on my query. Appreciate it.

      2. The thing is, there really is no obvious since we don’t know what lawmakers will do and how our returns will perform. There are only various scenarios.

        But actually, the obvious to me is that the government is inefficient and wants power. The other obvious is that we care more about our money and how to spend it than other people spending our money. The final obvious is that just earning w2 wages is inefficient.

  23. Thanks for the to on converting IRA funds to Roth. Being in the already fleeced category, I’ve not been too worried about my Roth IRA. When I get laid off or otherwise have low income I contribute and when I don’t, I don’t.

    Rather than worrying about tax rates being higher or lower in 30 years I worry more about the government stealing money from our retirement accounts. See last year’s “My IRA” lead balloon. It won’t be outright theft like Cyprus, ust a requirement that some % of all retirement accounts must be invested in government securities. There’s no way of the current crisis without something radically changing.

    But then again, how do you plan for the black swan?

    1. Ah yes, the “MyIRA” proposal that has seriously gone nowhere! I swear, I think I’ll just tune out whatever the government says because chances are, new proposed legislation will never pass.

      The only thing we can do with our retirement accounts and net worth is to diversify. Ideally, we’ll all be able to raise enough RISK FREE assets so that if everything else goes to hell, we’ll still be OK and happy.

  24. If you already have Traditional IRA assets, your 401(k) plan may allow you to roll them in so that you can avoid the pro-rata rule and do the entire backdoor Roth without tax consequence. Worth checking out.

    1. Did that last year it was very easy to do – recommend everyone do this PRIOR to doing the back door Roth.

      1. I did that as well to segregate pre-tax and after-tax in different retirement vehicles to minimize the impact of the pro rata rule. Was a little bit of a pain to try to keep track of the various transfers but worth it to maximize tax efficiency go forward. As of now, all pre-tax retirement is in my 401k, all after-tax/Roth retirement is in an IRA, so I can backdoor into the Roth as needed without tax worries.

        IMHO, the more important point for high income earnings to consider the backdoor Roth is the tax diversification. God knows what taxes are going to look like in the future, so having a mix of pre-tax, post-tax, and taxable savings will allow you to better prepare for all eventualities.

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