What is a backdoor Roth IRA and should I be doing one?
(This is the newsletter formerly known as Ready, Set, Grow Up, by Rae Votta)
Welcome to Ask The Group Chat, our first week with the new format and new name in place. Just as a reminder, every week I am answering questions from my readers, trying to help you figure out the life stuff you think you’re already supposed to understand. This week’s message comes from M, who is worried they might be missing out on something in their retirement planning.
Question: What is a backdoor Roth, and am I missing something by not doing it? I have $100,000 in a traditional IRA, $12,000 in a Roth IRA, and about $120,000 in my 401 K. I make over the threshold to contribute to a Roth IRA directly, can I do rollovers to save on taxes later? - M
Understanding the Roth vs Traditional IRA divide is one thing (I’ll get deep into that in another edition), but then you start hearing about this “backdoor Roth” concept. The trouble is, no one ever explains it fully, or how and when to do it.
For quick background, IRAs (Individual Retirement Accounts) are self-directed retirement savings accounts. Anyone can contribute up to $7,000 per year as of 2025 into a Traditional IRA and reduce their gross income for tax purposes, delaying the tax payments on that money until withdrawing it after age 59 and a half (or earlier with a hefty penalty). A Roth IRA, on the other hand, takes money that’s already been taxed at your current rate and then you withdraw it tax-free in retirement, locking in all that compound interest growth. However, there’s an income cap on who can contribute to a Roth, so once you are earning above a certain threshold, you cannot make contributions. In 2025, that individual limit is $165,000 in adjusted gross income, after which you cannot make any Roth contributions, unless you activate the often-discussed backdoor conversion.
It sounds so clandestine, so intriguing! Lurking in the shadows, the backdoor Roth to sneak your money into some elusive tax-free club! Of course, it’s not as sexy as all that. A backdoor Roth is taking money from a traditional IRA and converting it, paying taxes in the year you convert, and placing that now-taxed money into a Roth IRA instead to continue its growth. You are still limited to the maximum contribution per year ($7,000 for those under 50), but your process would be to contribute that to a traditional IRA, then immediately convert it into a Roth, paying the taxes.
Sounds super simple and everyone should do this, right?
Well, there are a few pitfalls to watch out for.
First, this strategy works best if you don’t have existing IRAs. The reason is that when you convert the money, it is considered a withdrawal event, and something called the pro-rata rule is applied. In simple terms, it makes you pay taxes on your money proportionately to your pre-tax and post-tax money in all your IRAs collectively. In your case, dear reader, you have a combined IRA balance of $112,000, so if you tried to convert the $7,000 into a Roth, you might assume you don’t need to pay taxes because you can’t be taxed twice. However, by law, you cannot dictate what exact funds are converted, and instead must go by a percentage rule aimed at keeping people from skirting the laws to eliminate their tax burden. In this case, 93.75% of the conversion would need to be taxed. As you continue to convert, you lessen this percentage over time, but it can result in unexpected taxes and complicated tax filings every year.
One option is to roll your entire IRA balance at once into a Roth, paying taxes at that time. However, your taxes are determined based on your annual income, and this money would be included in that calculation during that tax year. If you’re already in a high bracket, you’d be paying that $112,000 at the highest tax bracket, jumping you into an even higher tax bracket than your traditional income. This method is best considered in a year when you have little to no income (and often done at retirement age when you’re not earning anymore). You’ll see this in the retirement and financial influencer space referred to as filling up the buckets, meaning filling up buckets of tax brackets by taking “income” as a conversion every year. If you do this strategically, you can save hundreds of thousands in taxes over the long term of your retirement.
But if you have a long time to go until retirement, there’s a second option that will get you out of the pro-rata situation and unlock the backdoor Roth for you this year. It requires you to have self-employment income and open a solo-401K. This is like a traditional employee-sponsored 401K, but one you can fund as a self-employed business owner instead. Once you do that (and your traditional Roth has been open for more than 2 years), you can convert that traditional Roth completely into the solo-401K, eliminating the pro-rata considerations. Now you can start afresh and begin doing the $7,000 backdoor Roth strategy with only a Roth IRA open in your name. If you’re not self-employed, it is possible to roll a traditional IRA into an employer-sponsored 401K plan if your plan allows it, so that’s something to check out.
And finally, one important tip. You need to have your Roth IRA open for 5 years before you make withdrawals, so setting up conversions isn’t something you can do last minute. It’s good to start funding one as early as possible, so you’re clear of that restriction by the time you want to retire.
All that said above, maneuvers like backdoor Roth conversions are complex. I think most financially adult things you can manage without an advisor, but these complex tax strategies are something you shouldn’t do without talking to someone, at the very least someone at the company where you host your IRA or 401K.
The biggest takeaway is that you don’t “need” to be doing this strategy. The most important part of retirement planning is doing any saving at all. Tax strategy is awesome, but getting yourself into a good cadence of saving and planning should be celebrated. If this is your year for conversions, it’s fine. If you chug along as you already are and never do the conversions, it’s also fine. You’re doing great!
Quick Hits:
One of the best starter travel credit cards, the Chase Sapphire Preferred, has its best bonus points offer of the year now, 100,000 points after $5,000 of spending in three months with a $95 annual fee. Some watch-outs, you won’t qualify for the bonus if:
You already have a Preferred, or another Sapphire product like Reserve
You already received a bonus within the last 2 years for this card
Otherwise, it’s a great time to add it to your arsenal. More to come on why Chase is the best in a future letter, but I wanted to let you all know this is available now, as you must apply by May 12, 2025
Transparency - I can earn bonus Chase points via the link above, but it’s the same offer available if you simply Google the promotion. I won’t promote something to you without being honest about any potential kickbacks I get!
If you’re a Delta loyalist like me, make sure you’ve got your Uber account linked as their new partnership is kicking off. Delta previously partnered with Lyft, so this is a shift in how you can earn bonus points.
My friend Kenyatta recommended this essay (and collection of essays) that I had somehow missed in the chaos of the last few years: The dark forest theory of internet by Yancey Strickler. A must-read if you’ve felt that itchy-weird feeling about being a human online in the last half a decade.
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Reminder: I’m not a licensed financial advisor, and this is not financial advice. I’m just sharing my personal opinions with my group chat.