Week 15 Day 3: The Backdoor Roth: For High Earners

Step 1: Contribute $7,000 to a non-deductible Traditional IRA (no income limit). Step 2: Convert it to a Roth IRA immediately. Since you already paid tax on the contribution, the conversion is tax-free. You now have $7,000 in a Roth IRA growing tax-free forever. Legal, IRS-acknowledged, and available to everyone.

The backdoor Roth works because while Roth IRA contributions have income limits (phased out above $161,000 single / $240,000 married in 2024), Roth conversions have no income limits. The loophole: contribute to a Traditional IRA (anyone can do this, though deductibility depends on income), then convert to Roth. If the contribution was non-deductible, the conversion triggers little or no additional tax. Important caveat: the pro-rata rule. If you have existing pre-tax Traditional IRA balances, the IRS treats all your Traditional IRAs as one pool for conversion purposes. A portion of any conversion will be taxable proportional to the pre-tax percentage. Solution: roll existing Traditional IRA balances into your 401(k) first (if your plan accepts rollovers), leaving the Traditional IRA empty. Then the backdoor conversion is clean.

The backdoor Roth IRA strategy exists in a legal gray area that Congress has repeatedly considered closing but has not. The Build Back Better Act of 2021 included provisions to eliminate backdoor Roth conversions for high earners and mega backdoor Roth conversions entirely, but the legislation stalled. As of 2024, the strategy remains fully legal. The IRS addressed the step transaction doctrine concern (which could potentially collapse the two-step process into a single prohibited direct Roth contribution) in several private letter rulings and has never challenged backdoor Roth conversions. The mega backdoor Roth -- contributing after-tax dollars to a 401(k) beyond the $23,000 limit and converting to Roth -- allows up to an additional $46,000/year in Roth space ($69,000 total 401(k) limit minus $23,000 pre-tax limit). Not all 401(k) plans permit after-tax contributions or in-plan Roth conversions, so check with your plan administrator.