The backdoor Roth IRA offers a legitimate workaround that allows high-income earners to access Roth IRA benefits despite income restrictions. This tax planning strategy involves contributing after-tax dollars to a traditional IRA, then converting those funds to a Roth IRA.
While the process requires careful execution and understanding of specific tax rules, it can be a useful tool for building tax-diversified retirement savings. This guide explains how a backdoor Roth IRA works for 2025, including step-by-step instructions, tax implications, and common pitfalls to avoid. You have until April 15th, 2026 to make the initial after-tax contribution to a traditional IRA for the 2025 tax year.
A backdoor Roth IRA is not a special type of account. Instead, it’s a strategy that allows people whose income is too high for direct Roth contributions to contribute money to a Roth IRA indirectly.
Here’s how it works:
Once inside the Roth IRA, your contributions can grow tax-free, and qualified withdrawals in retirement are tax-free as well.
Direct Roth IRA contributions have strict income limits. As your modified adjusted gross income (MAGI) increases, eligibility phases out. For 2025, these limits are:
The Roth IRA contribution limit remains $7,000 for 2025 with a $1,000 catch-up contribution available to individuals age 50 or older ($8,000 total).
If your income falls within the phase-out range, you can make partial contributions. However, once you exceed those thresholds, direct Roth IRA contributions are prohibited. The backdoor strategy is now your primary option for accessing Roth benefits.
The backdoor Roth IRA strategy involves three essential steps:
Step 1: Open and Fund a Traditional IRA
If you don't already have one, open a traditional IRA. Make a non-deductible contribution using after-tax dollars, up to $7,000 for 2025 ($8,000 if you're 50 or older). Since your income is too high for a deductible IRA contribution, this is a nondeductible contribution.
Initially, keep the contributed funds in cash to avoid generating investment gains before conversion. Even small earnings can complicate tax reporting.
Step 2: Convert to Roth IRA Immediately
Once your traditional IRA contribution settles (typically within a few days), convert the balance to a Roth IRA. The keyword here is "immediately." Converting quickly minimizes the chance of earning investment gains that would be subject to taxation.
When done correctly, this step doesn’t create additional tax liability since you're moving after-tax dollars.
Step 3: Complete Required Tax Reporting
File Form 8606 (Nondeductible IRAs) with your tax return to document both the non-deductible traditional IRA contribution and the Roth conversion. This prevents double taxation by confirming with the IRS that the funds were contributed with after-tax dollars.
Your brokerage firm will also issue Form 1099-R (reporting the conversion) and Form 5498 (reporting the contribution) for your records.
Several IRS tax rules can affect the tax-free portion of your backdoor Roth IRA conversion. Consulting a professional tax advisor is recommended for proper execution of tax planning.
The Pro-Rata Rule
This IRS treats all your non-Roth IRAs as a single account when determining the taxable portion of any conversion. If you have existing traditional IRA balances containing pre-tax dollars (from deductible contributions or investment earnings), the pro-rata rule applies.
Example: Suppose you have $40,000 in pre-tax traditional IRAs and add $10,000 in after-tax contributions. A $10,000 conversion would be treated as 80% taxable ($8,000) and 20% tax-free ($2,000).
The IRS calculates this ratio based on your total IRA balance at the end of the year, not at the time of conversion. This rule can create substantial unexpected tax bills for those with existing traditional IRA assets.
Taxable Conversion Events
Any investment earnings that accrue between your contribution and conversion are subject to ordinary income tax. This is why financial advisors recommend completing conversions as quickly as possible, ideally within days of making the initial contribution.
Form 8606 Requirements
Filing Form 8606 is not optional, it's required to report non-deductible contributions and conversions properly. Without it, the IRS assumes your entire conversion is taxable income, potentially resulting in double taxation of after-tax contributions.
Each Roth IRA conversion has its own five-year holding period before withdrawing funds tax-free and penalty-free. Withdrawing converted amounts before this five-year window (and before age 59½) may trigger a 10% early withdrawal penalty.
Key Points:
Planning around the five-year rule ensures you don’t create taxable or penalized withdrawals.
Advantages
Potential Drawbacks
For high-income earners wanting to contribute even more to Roth accounts, some employer 401(k) plans allow a mega backdoor Roth IRA strategy.
How It Works
You make after-tax contributions to your 401(k) beyond the standard elective deferral limit, then convert those contributions to a Roth IRA or Roth 401(k).
2025 Contribution Limits:
Not all employer plans allow after-tax contributions and in-plan Roth conversions, so check with your plan administrator first.
Backdoor and mega backdoor Roth IRA strategies give high-income earners access to tax-free retirement growth and valuable tax diversification. However, because IRS rules are complex and mistakes can be costly, careful planning and compliance are crucial.
If you’re considering a backdoor Roth IRA, consulting a financial advisor or tax professional can help ensure you maximize the benefits while avoiding costly errors.
Contact an LTax specialist to determine if it's the right strategy for your retirement plan.
LEGAL OR TAX: The information herein is not legal, such as trust or estate planning, advice, or tax advice. Any such information is provided for illustrative purposes only and must not be relied upon without the benefit of the advice of your lawyer and/or tax professional. Lido specifically disclaims any liability from any reliance on such information. Lido is not a legal service provider or tax professional and does not offer legal or tax advice. Should you desire to obtain tax or legal services or advice, you must enter into your own, independent engagement agreement with a licensed attorney or tax professional.