Funding a Roth IRA Through the Backdoor

By Yvonne Marsh, CFP®, CPA

Do you make too much money to contribute to a Roth IRA?  Or wish you could add more than the $6,000 – $7,000 allowed each year?  There’s a solution for both of those issues, called a backdoor Roth strategy.  It avoids the income limits of traditional Roth IRA’s, and it’s done within your employer retirement plan.  If you’re self-employed, set up your own individual 401k plan and start saving!

As a little background, there are three types of retirement account contributions:  pre-tax, after-tax and Roth:

  • Pre-tax contributions are tax-deductible, but all withdrawals from the account are taxed at ordinary income rates when it’s withdrawn.
  • After-tax contributions are nondeductible, though the growth is tax-deferred. That growth is taxed when it’s withdrawn.
  • Roth contributions are nondeductible and they also grow tax deferred. But the growth of the account is also tax free when withdrawn!

We can all agree that tax-free Roth dollars are the “best” dollars in retirement, and here’s how you can accumulate more of them:

In 2020, people age 50 and over can add up to $26,000 in employee pre-tax contributions.  Yet there is a second limit of $63,500 in total additions to your retirement accounts, including your employer contributions. As an example, my client was maxing out his contribution of $26,000 and had an employer contribution of $4,500, so a total of $30,500 was added to his 401k.  He lamented the fact that he makes too much money to contribute to a Roth IRA.  But I pointed out to him that his 401k plan allows for after-tax contributions too. He still had room to add another $33,000 before he hit the $63,500 limit in total annual additions. And why is this so important?  The IRS has ruled that after-tax contributions can be rolled over to a Roth IRA, thus transforming not just the after-tax contributions but all future growth of those contributions into a beautiful, tax free asset. 

There are several aspects that have to be considered:  (1) your employer plan rules (2) the timing of the Roth rollover (3) investment decisions before and after rollover and (4) what the IRS defines as being eligible for rollover.  Some tax strategies need professional guidance, and this is one of them.  Are you on the path to a tax-free retirement? We know how to get you there.