How to Set Up a Backdoor Roth IRA - NerdWallet

How to Set Up a Backdoor Roth IRA

401(k), Financial Planning, Investing, Investing Strategy, Roth IRA
How to Set Up a Backdoor Roth IRA

You may think a high income will shut you out of Roth IRA eligibility, but there’s another way in: a backdoor Roth IRA. And it can save you thousands of dollars in taxes.

Roth IRAs are retirement accounts that allow you to sock away money you’ve already paid taxes on. One of their big selling points is that you get to withdraw that money — and any investment gains — tax-free when you retire. So if you’re in, say, the 15% tax bracket now but expect to be in the 28% tax bracket when you retire, a Roth IRA can save you a ton of money later in life.

Here’s the thing, though: High earners can’t contribute to Roth IRAs. The government allows only those people with adjusted gross incomes below $194,000 (married filing jointly) or $132,000 (single) in the front door. (Find out how much you can contribute to Roth and traditional IRAs.)

The rules are different for traditional IRAs: Anybody can contribute, regardless of income. If you’re also covered by an employer retirement plan, however, your ability to deduct your contribution begins to phase out at a certain income level. NerdWallet has a quick calculator to show you how much of your traditional IRA contribution is deductible.

So why not just put the money in a traditional IRA and leave it at that? One word: taxes. Remember, withdrawals from a Roth IRA in retirement are tax-free. If you were shut out of a Roth IRA and still want your tax break in retirement, a backdoor Roth gives you that chance.

What is a backdoor Roth IRA?

A backdoor Roth IRA boils down to some fancy administrative work: You put money in a traditional IRA, convert the account into a Roth IRA, pay some taxes and, lo and behold, you’ve got tax-free income in retirement. Even though you didn’t qualify for a Roth IRA to start, you get to sneak in the back door anyway.

It all works because, in 2010, the federal government removed the income limits for IRA conversions, creating a Roth IRA loophole. Of course, you’ll need to get the mechanics right. Here’s a step-by-step guide on how to make a backdoor Roth IRA conversion.

  1. Put money in a traditional IRA account. You might already have an account, or you might need to open one and fund it. If you’re opening an account specifically to do a backdoor IRA, you can fund your account with post-tax dollars and not have to worry about paying taxes on that money, and what it earns, in retirement. (See our picks for the best traditional IRA providers.)
  2. Convert the account to a Roth IRA. Your IRA administrator will give you the instructions and paperwork. If you already have a Roth IRA with the IRA administrator, your “converted” balance will probably go right into your existing Roth IRA. If you don’t already have a Roth IRA, you’ll open a new account during the conversion process. (See our list of the best Roth IRA accounts.)
  3. Pay taxes on the contributions to your traditional IRA. Remember, only post-tax dollars get to go into Roth IRAs. So if you deducted your traditional IRA contributions and then decide to convert your traditional IRA to a backdoor Roth, you’ll need to give that tax deduction back. In other words, you’ll need to pay taxes on the money you contributed, just like everyone else who invests in a Roth IRA.
  4. Pay taxes on the gains in your traditional IRA. If the money in that traditional IRA has been sitting there awhile and there are investment gains, you’ll need to pay taxes on the gains as well when you convert to a Roth IRA. You will report this on your federal income tax return in April.

One side note: If you have a traditional IRA and you’ve been able to deduct the contributions, you may be tempted to throw in some extra cash over and above the amount you’re allowed to deduct. The strategy here is to then convert just that extra, nondeductible portion into the Roth IRA. Think again. The IRS requires rollovers from traditional IRAs to Roth IRAs to be done pro rata. That means if you convert, say, 20% to a Roth IRA, the IRS requires you to convert 20% of the contributions that were deductible and 20% of the contributions that weren’t. You can’t cherry-pick.

Best providers for your Roth IRA

TD AMERITRADE: AMONG BEST OVERALL

TD Ameritrade is one of our picks for best overall IRA providers. The popular online broker has wide customer appeal for IRA account holders and beginner investors alike for several reasons: helpful customer service, a $0 minimum balance requirement and a large selection of commission-free exchange-traded funds (ETFs) and no-transaction-fee mutual funds. Advanced, active traders also gravitate to the company because of its two top-notch trading platforms — including widely renowned thinkorswim — and its research and data. The downside: The company’s trade commissions are on the high side at $9.99.

E-TRADE: NO ACCOUNT MINIMUM

E-trade is one of our picks for best providers with no account minimum for IRA accounts. One of the best-known online brokers, the company is loved by investors because of its user-friendly online experience on both its website and mobile app. E-Trade has a large selection of no-transaction-fee mutual funds and commission-free ETFs. Research and data are free, and E-Trade’s tiered commission structure means frequent traders can keep costs down.

WEALTHFRONT: GOOD FOR HANDS-OFF INVESTORS

Wealthfront, one of our top picks for hands-off IRA investors, was one of the first robo-advisors in the game. It remains one of the largest, and it regularly adds new features and tools for its investors. The company is a great option for IRA account holders who are looking for investment management, particularly beginners, because it waives its 0.25% account management fee on balances of $10,000 or less. Wealthfront has a $500 account minimum and invests its clients in a portfolio of ETFs with expense ratios that average a modest 0.12%.

BETTERMENT: NO MINIMUM, TIERED FEES

Betterment, our other top pick for hands-off investors, has carved out a place as the largest independent robo-advisor. It caters to the retirement market with innovative goal-based tools to help investors save more. The company requires no minimum investment and offers a tiered management fee that starts at 0.35% for balances under $10,000 (with auto-deposits of at least $100 a month). The fee drops to 0.25% on balances between $10,000 and $100,000; balances over $100,000 pay just 0.15%. Betterment’s portfolio of ETFs have expense ratios that range from 0.09% to 0.17%.

» MORE: See our full list of top Roth IRA providers

Tina Orem is a staff writer at NerdWallet, a personal finance website. Email: torem@nerdwallet.com.

Arielle O’Shea contributed to this post. Email: aoshea@nerdwallet.comTwitter: @arioshea.

This post was updated August 10, 2016.


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  • Yasu

    Thanks, Joanna! Helpful and informative info on the subject.

  • E from WA

    Thanks, Joanna! I’m excited. My question? Rather than putting the whole amount of $5,500 into a traditional IRA and then converting it over to a Roth can I contribute monthly to the IRA and convert monthly to a Roth? Example: 458.33 per month, to IRA and then convert immediately to Roth IRA and do this each month?

  • Pingback: Income Too High for a Roth IRA? Try sneaking in the backdoor()

  • E from NE

    I’m with E, I want to make monthly contributions. Is it better to
    1. Convert the contributions each month immediately
    2. Wait until the end of the year and convert all at once

  • h

    Very good article. Thanks Joanna. This year my income limit will prohibit me to do Roth IRA and I am thinking to do this backdoor traditional IRA. I do have little money in my traditional IRA from many years before, when I was eligible for deductible traditional IRAs. If I understood the Pro-rata rule, I think I should convert those older ones to Roth as well (and not just the backdoor one) , before I file my taxes for this year. Is that correct?

  • Geo

    I am not sure if I am following the “The contribution is NOT tax-deductible because of her high income” part … Looking at the IRS web site, it says that as long as my work doesn’t offer a retirement option, it doesn’t matter what my income is, a traditional IRA *IS* deductible.
    http://www.irs.gov/Retirement-Plans/2013-IRA-Deduction-Limits-Effect-of-Modified-AGI-on-Deduction-if-You-Are-NOT-Covered-by-a-Retirement-Plan-at-Work

    Therefore: If I try to do this backdoor method:
    Put 5K in traditional
    No taxes
    Convert to Roth IRA … Pay taxes.

  • Thank you for the very clear explanation about how to do this. Do I have one question though: my wife and I file jointly (our income exceeds the threshold); can we both do this for a total of $11K or is our joint total $5.5?

    Thanks!

  • stringer

    For the last two years I have put the max into a non deductable IRA and immediately converted it to a ROTH. My taxes show that $5500 at a taxable event. Since I roll it over right away I usually don’t have any gains. I use H&R Block, are they doing it wrong.

  • Danny

    Question, I contribute 6500 each year to a Roth IRA, I am now over 55. Could I also contribute to a traditional IRA up to the limit and then convert ?

  • C in FL

    I have both a traditional and a ROTH IRA account. Next year I will be over the income limit to be able to contribute to my ROTH. If I roll over my traditional IRA into my employer’s 401k plan in April, can I then contribute to the traditional IRA (now at zero balance after being rolled into the 401k) and do a backdoor ROTH conversion later in the same calendar year without having to worry about the prorata rule?

  • EP

    I have a 401k offered through my employer with deductable assets, but no ira accounts. Am I able to complete the backdoor roth ira without converting my 401k? Does a 401k have anything to do with all of this?

  • Maxim

    One thing to also mention is.. what if you already have a traditional IRA account?

    For e.g., you already have $50,000 in a TIRA. For 2013, you want to contribute $5000 and convert that to a Roth IRA. You get taxed on 90% of the entire conversion (45/50) and the 5000 is taxed

  • John B

    Help! Hey Joanna, thank you so much for this page. I followed the instructions and everything went great except now I’m doing my 2013 taxes. Fidelity sent me a 1099-R that shows 5500 for gross distribution and 5500 for taxable amount. It also has a check in 2b for taxable amount not determined. When I entered this information into taxact.com where I do my taxes, it shot my taxes up by $1925! Is the problem that the tax software isn’t sophisticated enough?

  • Ming Hsueh

    Joanna,

    I have money currently residing in a Traditional IRA, but my company will allow me to roll this money into my companies 401K plan. If I roll the money into a 401K plan, do I still need to include it as part of the basis in the Pro-Rata Rule?

    Thank You.

  • AT401k

    I have been contributing the max on both a pre-tax and after tax basis to my 401k for many years. This enables me to receive my company match and is a forced savings plan. For the after tax portion I know the earnings will be taxed at ordinary tax rates, likely higher than if I had contributed, instead over the years to a taxable account, where earnings would have been taxed at long- term capital gains rates. How can I minimize the tax impact when it comes time to roll over and tap into these funds, which are now considerable? I realize now the error of my ways. How can I dig out?

  • Matt from Austin

    Technicality question: I contributed the full amount to the Roth IRA in 2013 and my income phased me out completely. To solve the excess contribution, I recharacterized it as a traditional IRA (funded with post-tax money).

    It’s now 2014 and I’m reading this article. Can I convert this account to a Roth IRA now given the initial recharacterization?

    Anyone can answer :) Thanks!

  • snobbyjelly

    I try many system to earn money online. But i had huge loss. Then i used ANDY LANK CASH FLOW i had no loss and i got huge profit.

  • Maria Soprano

    I contribute monthly to a Roth IRA and max it out each year. In the past 5 years, I’ve had to recharacterize anywhere between 20% to 70% my yearly Roth IRA contributions to a traditional IRA. So I’ve accumulated enough in the traditional IRA through conversions alone. The question here is… Can I recharacterize whatever amount from my Roth IRA to my traditional IRA, then turn around and do a backdoor contribution from my traditional IRA back to my Roth IRA?

  • Ik

    I have a roth withdrawal question. I have 2 separate roth accounts. Contributed upto the limit ($5500) to each in separate years. One account has grown and the second account is down from the original $5500. Can I take a tax free/penalty free withdrawal upto my total contribution of $11000 out of the account that’s sitting with a gain?

    • Hi there – thanks for reaching out to us! This is a great question to post on our Ask an Advisor platform (https://www.nerdwallet.com/ask). It’s completely free, and once your question has been posted, you should hear back from an advisor within a few days.

  • Nathan

    So The OP needs to create a traditional IRA account every year?

    • Hi Nathan – thanks for reaching out to us! We’re working on updating this post to reflect current information. Apologies for any confusion, but we appreciate your patience.

      If you have additional questions/concerns, feel free to email us at advice@nerdwallet.com!