April 20, 2023April 21, 2023 by Jason Brooks

Considerations and Pitfalls of Back Door Roth

Finspire Insights

Back Door Roth

by Jason Brooks, CFP®, CPA
Vice President, Private Wealth Management
Finspire, LLC

April 5, 2023

There has been a lot of talk about Roth IRAs lately and the concept of a “Backdoor Roth IRA.” This is a roundabout way of contributing to a Roth IRA when your income exceeds the IRS set thresholds.

Below are items to consider and potential pitfalls.

Who should consider a Backdoor Roth IRA?

Your income is more than the Roth IRA contribution income limits. For the 2023 tax year if you are a joint taxpayer you cannot contribute to a Roth IRA if your modified adjusted gross income (MAGI) is more than $228,000. Partial contributions are allowed if your MAGI is between $218,000 and $228,000.
You have maxed out your traditional 401(k) (pre-tax) contributions and have some additional funds for savings. If your joint income is more than the limits above, it usually makes sense to contribute to your company retirement plan on a pre-tax basis as you are most likely in the 24% or higher marginal tax bracket.
How does it work? You first need to contribute (non-deductible) to a traditional IRA account and then transfer those funds over to a Roth IRA.

Who should not consider a Backdoor Roth IRA (Potential Pitfalls)?

For some people, a Backdoor Roth IRA strategy does not always make sense as there are some tax implications and special rules that can be tricky to navigate.

You already have a traditional IRA with a material balance. There is something called the pro rata rule which applies when an investor has a traditional IRA. This rule is used to determine the ratio of after tax to pre-tax assets in your IRA. The IRS requires you to include the value of all your non-Roth IRAs in this calculation.
- Example: Suppose you earn above the income threshold for making a Roth IRA contribution and have $93,000 of pre-tax money already in a traditional IRA, and you want to make a Backdoor contribution to a Roth IRA account of $7,000. First you would make a non-deductible traditional IRA contribution of $7,000, bringing your account balance up to $100,000. At this point, you might think you can convert the $7,000 after-tax portion to the Roth IRA and be done. However, this is where the pro rata rule would apply. The rule would dictate that of the $7,000 you plan to convert 93% ($93,000 pre-tax portion divided by the $100,000 total) of the $7,000 conversion would be taxable to you. Only 7% of the $7,000 Roth conversion would be tax-free. This would also leave $6,510 (93% of $7,000) of after-tax funds in the traditional IRA and would complicate your next conversion further.
An important consideration You will need to consider the value of all your traditional IRAs, SEP IRAs, and Simple IRAs to determine the pro-rata portion that is after tax. Inherited IRAs, 401(k) and 403(b) plan balances are excluded from the pro rata calculation. If you are a taxpayer filing a joint tax return, your IRA(s) are not combined with your spouse’s IRA(s) for purposes of the pro rata rule.

As always, it is important to consult a tax or investment professional before making these important decisions.

Important Disclosures:

Securities offered through IFP Securities, LLC, dba Independent Financial Partners (IFP), member FINRA/SIPC. Investment advice offered through IFP Advisors, LLC, dba Independent Financial Partners (IFP), a Registered Investment Advisor. IFP and Finspire, LLC are not affiliated.

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