Roth IRA rules limit the amount of money you can earn and still make a contribution. However, there is a legal strategy you can employ to get money into a Roth IRA, even if you exceed the Roth IRA income limits. This technique is known as a backdoor Roth IRA. Here’s a look at the current Roth IRA contribution income limits, how you can get around them, and why you might want to invest in a backdoor Roth IRA.
Maximum Income for Roth IRA
The IRS uses your modified adjusted gross income to determine if you qualify to make the maximum Roth IRA contribution, which is $6,000, or $7,000 if you’re age 50 or older. If you exceed the Roth IRA max income to make a full contribution, there’s a range of income in which the IRS allows you to make a reduced contribution. And there are Roth IRA limits above which you can’t make any Roth contribution at all. The ranges, based on different filing statuses, are as follows:
- Married filing jointly:
- MAGI less than $204,000, full contribution
- MAGI at least $214,000, no contribution
- Single, head of household, married filing separately:
- MAGI less than $129,000, full contribution
- MAGI at least $144,000, no contribution
- Married filing separately:
- MAGI less than $10,000, reduced contribution
- MAGI $10,000 or more, no contribution
How to Set Up a Backdoor Roth IRA
A backdoor Roth IRA sidesteps Roth IRA income limitations by funneling money through a traditional IRA. A traditional IRA has no income limits for contributions, unlike a Roth IRA, so you can open a traditional IRA no matter what your income is.
Once you’ve established your traditional IRA, you can either convert it to a Roth IRA or transfer the money to an existing Roth. Either way, the procedure for a backdoor Roth IRA is the same: You make a contribution to a traditional IRA, and then you convert that money to a Roth IRA.
Tax Considerations for a Backdoor Roth IRA
An important consideration in the backdoor Roth IRA strategy is the taxation of the transfer. Your traditional IRA was likely funded with pre-tax money, which means you took a tax deduction when you made your original contribution. Roth IRAs are funded with after-tax money, meaning if you transfer money from your traditional IRA to a Roth IRA, the entire balance becomes immediately taxable. The IRS does allow nondeductible contributions to traditional IRAs, which are made after-tax.
If you transfer after-tax contributions from a traditional IRA to a Roth IRA, you might expect that your transfer would be tax-free — and if that is your only IRA, you’d be correct.
However, the IRS doesn’t allow you to “cherry pick” which of your traditional IRA contributions convert to a Roth. Rather, it considers all of your IRA balances to be one large account, no matter how spread out they are. Thus, if you have $10,000 in a nondeductible IRA and $90,000 in a pre-tax IRA, 90 percent of whatever money you transfer to your Roth IRA will still be taxable, regardless of which account you draw from.
Benefit of a Backdoor Roth IRA
The reason some investors want their money in a Roth IRA rather than a traditional IRA is for the tax benefit in retirement. Whereas both pre-tax contributions — and all earnings — in a traditional IRA are taxable upon distribution, neither contributions nor earnings are taxable when you withdraw them from a Roth IRA.
Although you’ll pay a 10 percent penalty if you take your money out before age 59.5 — just as you would with a traditional IRA — your money always grows tax-free in a Roth. Another benefit is that there are never any mandatory distributions from a Roth IRA; with a traditional IRA, mandatory distributions begin after you turn age 72.
Time Might Be Ticking
The “Build Back Better” legislation proposed by the Biden Administration and approved by the House would severely curtail the use of backdoor Roth IRAs, particularly for wealthier individuals. Although the legislation has yet to be approved by the Senate, if it makes its way into law, there are two major changes that would apply to the backdoor Roth IRA.
First, any after-tax contributions to retirement accounts like traditional IRAs and 401(k) plans would be prohibited from being converted into Roth savings. Second, savers with incomes above specified limits would be prevented from converting pre-tax savings in retirement accounts into Roth savings. The proposed income limits are $400,000 for singles, $425,000 for heads of household and $450,000 for married couples.
If you’re considering a backdoor Roth IRA, talk with a financial advisor or an accountant about whether or not the technique could be appropriate for you.
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- Internal Revenue Service. 2021. "Retirement Topics - IRA Contribution Limits."
- Internal Revenue Service. 2021. "IRS announces changes to retirement plans for 2022."
- Internal Revenue Service. 2022. "Retirement Topics — Required Minimum Distributions (RMDs)."
- Congress.gov. 2022. "H.R.5376 - Build Back Better Act."