Backdoor Roth Conversions: How This Retirement Savings Strategy Works and Who Should Use It

“If you’re young and expect to be in a higher tax bracket in the future, use a Roth!” must be one of the most repeated pieces of basic financial advice out there.

And that’s for good reason: a Roth IRA is a type of tax-advantaged retirement account and because you fund it with after-tax dollars in the year you contribute, your earnings and future withdrawals after age 59 and 1/2 can be made tax-free.

This is why the advice is to use a Roth IRA while you’re younger (so the money in the account has as much time as possible between now and retirement to compound and grow) and while you’re in a lower tax bracket (since you’re taxed on the money you contribute, it’s better to pay taxes in a lower income bracket now than pay when you’ll be taxed more later).

There are, however, a few limitations with Roth IRAs — like the fact that once you make a certain income, you can no longer contribute directly to these accounts. Once you make $139,000 if you’re single or $206,000 if you’re married and file taxes jointly, you can’t put money straight into your Roth.

But you can still fund a Roth IRA if you know the right strategies to use.

How Backdoor Roth Conversions Help You Contribute to a Roth (Even If You Earn Too Much)

It’s worth figuring out how to get money into a Roth IRA even if you exceed the income limits. Yes, you can use other investment accounts to build your nest egg — but none of them offer the Roth IRA’s tax advantage of withdrawing money in retirement and not being taxed on those funds.

So how do high earners and high-income households take advantage of Roth IRA accounts even if when earning too much to contribute directly? You use a backdoor Roth conversion, an important strategy to utilize as part of managing future taxes on your retirement funds.

While you can’t contribute directly to a Roth IRA once you start making a certain amount of income, the IRS does allow you to contribute to a traditional IRA — which anyone earning an income can contribute to — and then convert those funds into a Roth IRA.

These are backdoor Roth conversions, and doing them now can be hugely beneficial to you once you reach retirement. 

Why Backdoor Roth Conversions Could Be a Critical Retirement Savings Strategy

If you simply leave the money in a traditional IRA, you may get a tax break today, but you’ll pay taxes on that money when you withdraw it in retirement.

You also probably already have access to a tax-deferred account (which is what a traditional IRA is) via your employer-sponsored retirement plan (like a 401(k), 403(b), SIMPLE IRA, etc).

If all of your retirement money is in tax-deferred vehicles, you’ll maximize how much you save on your taxes today. Contributions to these accounts are not counted as part of your taxable income in the year you make them.

But then you’re left with a potential problem in the future, when the main source of funds for your retirement will be taxed in the year you make withdrawals. Most retirees want to minimize the amount of taxes they need to pay on retirement income, but this is tough to do when all of it is taxable!

Backdoor Roth conversions allow you to avoid that kind of situation where the only source of funds in retirement creates a large amount of taxable income. Remember, money in a Roth grows tax-free and qualified withdrawals aren’t included in your taxable income.

By doing backdoor Roth conversions, you can spread your tax liability between the present and the future, instead of ending up at an extreme where you’re heavily taxed either today as you contribute or tomorrow when you withdraw.

How to Take Advantage of Backdoor Roth Conversions (and Things to Think About First)

Backdoor Roth conversions aren’t a way to dodge taxes — but they can be complicated processes that you need to ensure you manage properly to avoid a messy tax situation.

This is especially true if you already have an IRA with money in the account, which presents added complexity that you may want to discuss with a financial planner before you attempt a conversion on your own.

Misunderstanding the IRS rules around how to convert IRA money into a Roth IRA when you already have an established IRA that’s been funded with pre-tax dollars can trigger some nasty tax consequences, so it’s worth working with a professional to evaluate your specific situation and to provide guidance on the right way to do a conversion without ending up with an unpleasant tax bill next year.

If you’re looking at doing a Roth conversion on your own and you don’t currently have a traditional IRA, you’ll need to establish a traditional IRA and fund it. (You also need a Roth IRA where the funds will eventually land.)

Next, contact the account’s custodian to start the conversion process and fill out the required paperwork to initiate the transfer. The funds will move from your IRA to Roth IRA.

Regardless if you handle this process on your own or you work with a financial planner to help you, you should be prepared to pay taxes on the money you converted. Even though you contributed to a traditional IRA, the move to the Roth IRA means those funds are treated as part of your taxable income for the year.

Backdoor Roth conversions can be a smart move to make as part of your overall retirement savings strategy, especially if you can’t contribute to a Roth otherwise. It’s one way to make your tax planning more efficient so that you can keep more of your hard-earned dollars earmarked for retirement in your pocket.