A Backdoor Roth IRA Isn't as Sketchy as It Sounds. Here's Why

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  • If you make too much to contribute directly to a Roth IRA, the backdoor method can be the right choice for you.
  • It might sound like a shady workaround at first, but a backdoor Roth IRA is perfectly legal.

Don't think you can't use a Roth IRA even with a higher income.

Roth IRAs are designed to help lower- to middle-income Americans save for retirement and create a tax-free income stream for later in their life. And as a result, the ability to contribute to a Roth IRA is income-restricted.

This is a big difference between Roth and traditional IRAs. With a traditional IRA, your ability to deduct your contributions is only limited by your income if you or your spouse are eligible to participate in a retirement plan at work, but all investors are subject to the Roth IRA income limits. For 2022, the limits are as follows.

Tax Filing Status 2022 Adjusted Gross Income Limits
Single $129,000 - $144,000
Married Filing Jointly $204,000 - $214,000
Married Filing Separately $0 - $10,000
Data source: IRS.

Here's how this works: If your income is below the lower limit for your status, you can make a full contribution to a Roth IRA. For 2022, the annual limit is $6,000 ($7,000 if you're 50 or older). If your income is above the higher limit, you cannot contribute directly to a Roth IRA. If your income is in the middle, you can make a partial contribution.

The backdoor Roth IRA method in a nutshell

If your income exceeds the high end of the range in the chart, you cannot contribute directly to an IRA. However, you can contribute to a traditional IRA and immediately convert the account to a Roth IRA. This is the main idea behind the backdoor method.

The reason this works is that although the traditional IRA tax deduction is income-restricted for certain people, anyone can contribute to a traditional IRA account. And there is no income restriction whatsoever when it comes to Roth IRA conversions. There aren't even any tax implications if you convert the account before you claim any traditional IRA tax deduction or invest the money.

The process is actually rather painless. The basic steps are:

  • Open a traditional IRA account with the broker of your choice.
  • Make a contribution to the account (but don't invest it yet or claim it as a tax deduction).
  • Fill out an IRA rollover form that authorizes the transfer of the account's assets to a Roth IRA.

Is a backdoor Roth IRA the right move for you?

So, the backdoor method of contributing to a Roth IRA is a perfectly legal way to set yourself up for tax-free retirement income. But it's important to determine if a Roth IRA is right for you before you start the process.

Specifically, Roth IRAs are typically most beneficial for people in the lower tax brackets now -- that is, those with low to mid income. Think of it this way. If you're in the 10% or 12% tax bracket right now, it makes a lot of sense to contribute to a Roth IRA and pay the tax on your contribution. By doing so, you're effectively locking in that low tax rate on your retirement savings. However, if you're in a high tax bracket -- say, a 37% marginal tax rate -- the math doesn't look quite as good. A $6,000 Roth IRA contribution would cost more than $9,500 of your income to make, when factoring in the tax hit.

To be sure, there are some other good reasons why a Roth might be appealing. Maybe you want the ability to withdraw your contributions at any time without penalty. Maybe you don't want to worry about required minimum distributions, or RMDs, after you retire. Or maybe you want to create a stream of tax-free retirement income for other reasons, such as avoiding taxes on your Social Security benefits. Whatever the reason, it's important to weigh the pros and cons to ensure that using a backdoor Roth IRA is the right move for you.

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