For high-income earners, investing in a Roth IRA isn’t always straightforward. The IRS limits who can contribute directly based on income. In 2025, single filers with modified adjusted gross income above $165,000 and married couples filing jointly above $246,000 are excluded from making direct Roth IRA contributions.
Fortunately, there’s a strategy that allows those above the income threshold to still access the benefits of Roth savings. It’s called a Backdoor Roth IRA.
What is a Backdoor Roth IRA?
A Backdoor Roth IRA is a two-step process that provides a legal workaround to Roth contribution limits:
- Contribute to a traditional IRA (no income limits apply for contributions).
- Convert that traditional IRA into a Roth IRA.
While you’ll pay taxes on the conversion of pre-tax dollars, the long-term benefit is that once funds are in a Roth IRA, they can grow and be withdrawn tax-free in retirement.
Why High-Income Earners Use Backdoor Roth IRAs
For many professionals, the Backdoor Roth IRA is the only way to access Roth benefits. Key advantages include:
- Tax-free growth: Over decades, avoiding annual taxation can mean significantly larger balances in retirement.
- Tax diversification: Balances in both pre-tax and Roth accounts provide flexibility when planning withdrawals.
- Future tax planning: Converting now may make sense if you expect to be in a higher bracket later.
- No Required Minimum Distributions (RMDs): Roth IRAs don’t require withdrawals at age 73, allowing funds to remain invested longer.
Consider a 40-year-old professional earning $300,000 annually. Because their income is well above the Roth IRA contribution limit, they cannot contribute directly to a Roth IRA. However, by using the backdoor Roth strategy, they contribute $7,000 each year to a traditional IRA and immediately convert it to a Roth IRA.
Over the next 25 years, assuming a 7% average annual return, those steady $7,000 annual conversions could grow to more than $400,000 in tax-free Roth assets by age 65. That balance could then be tapped in retirement without triggering additional federal income tax, unlike withdrawals from traditional pre-tax accounts.
How the Backdoor Roth Works in Practice
At first glance, the process seems simple: make a traditional IRA contribution, then convert it to a Roth IRA. But the details matter. Rules around existing IRA balances, reporting requirements, and timing can complicate the strategy. Missteps can lead to unexpected taxes or penalties.
Common Backdoor Roth Pitfalls to Avoid
Keep reading to discover some of the most common mistakes to avoid when setting up a Backdoor Roth IRA.
The Pro-Rata Rule
The IRS considers all of your traditional IRAs together when calculating taxes on a conversion. If you hold both pre- and after-tax dollars, a conversion will be treated proportionally.
Example: If you have $100,000 in traditional IRAs, with only $7,000 already taxed, just 7% of a $7,000 conversion would be tax-free. You would owe taxes on the remaining 93%, equaling $6,510 – not ideal.
It’s easier to manage conversions and minimize tax implications by keeping funds in different accounts. For example, many investors get around this by rolling pre-tax IRA balances into an employer 401(k), leaving only after-tax contributions in the IRA for conversion.
The Step Transaction Doctrine
The Step Transaction Doctrine means that the IRS could challenge your back-door transfer, especially if the transfer happens immediately after the contribution to the traditional IRA. Essentially, they could argue that the contribution and transfer constitute “one step” and therefore violate the rule against Roth IRA contributions for high earners. The IRS has not aggressively used this doctrine of late, but they could in the future and the risk remains.
Form 8606 Reporting
Form 8606 tracks non-deductible IRA contributions and ensures you aren’t taxed twice on the same money. If you’re preparing your first Backdoor Roth IRA without an accountant, Form 8606 can be a major stumbling block. If you misreport your information on this form, even by accident, it can trigger unexpected taxes and penalties.
Other Common Pitfalls:
- Double taxation risk: Failing to track after-tax contributions properly can cause you to pay tax twice.
- Timing issues: Missing conversion deadlines or contributing above limits can result in penalties.
- Legislative risk: Congress has previously considered eliminating the Backdoor Roth. Anyone using the strategy should monitor potential changes.
How a CPA Advisor Can Help
A Certified Public Accountant, also known as a CPA, specializes in compliance and tax optimization. With a Backdoor Roth IRA, a CPA can:
- Calculate potential tax liability under the pro-rata rule.
- Make sure contributions and conversions are reported correctly on Form 8606.
- Track basis to avoid double taxation.
- Advise on contribution timing to minimize IRS scrutiny.
How a CFA Advisor Can Help
A CFA, also known as a Chartered Financial Analyst, brings expertise in investment management and financial planning. A CFA can:
- Design a long-term growth strategy for your Roth account.
- Align Roth investments with your broader portfolio.
- Balance tax management and efficiency across all accounts (401(k), taxable, Roth).
- Develop withdrawal strategies that optimize both pre-tax and Roth assets in retirement.
With the help of both a CPA and a CFA, you’ll get a comprehensive approach, ensuring the strategy is executed correctly and the assets inside the Roth are also effectively managed.
Example: Professional Guidance in Action
Consider Jane, age 42, earning $250,000 with $150,000 in a Traditional IRA. She contributes $7,000 and converts it, only to discover she owes nearly $6,500 in taxes due to the pro-rata rule.
With a CPA’s guidance, Jane could have first rolled her pre-tax IRA balance into her employer’s 401(k), isolating her after-tax contribution. A CFA would then help her invest those Roth assets for long-term growth.
Jane could have consulted these professionals upfront, potentially avoiding thousands in unnecessary taxes while positioning herself for decades of tax-free compounding!
Final Thoughts
The Backdoor Roth IRA can be a valuable tool for high earners prioritizing wealth management, offering tax-free growth, tax diversification, and flexibility in retirement. But the strategy comes with nuances, and errors can be costly.
Working with a CPA or even a remote advisor helps you comply with IRS rules and avoid reporting mistakes. Partnering with a CFA ensures your Roth assets are invested strategically as part of a broader financial plan and retirement planning.
If you’re considering a Backdoor Roth IRA, consult with a CFA and CPA to help you navigate the complexities and maximize the benefits.
Disclaimer: There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual. All investing involves risk, including loss of principal. No strategy ensures success or protects against loss.