What is a backdoor Roth IRA?

Also called a Roth conversion, a backdoor Roth IRA is done by transferring funds from a tax-deferred retirement account, such as a traditional 401(k) or IRA, to a tax-free Roth IRA.

Once your earnings exceed the income limits ($7,000, or $8,000 if you’re 50 years of age or older) set by the Internal Revenue Service (IRS), the only way to add funds to a Roth IRA account is through a backdoor Roth. 

Whether you’re even eligible to contribute to a Roth IRA (and how much) depends on your modified adjusted gross income (MAGI). But even if you can’t make regular contributions, it’s still possible to add funds via a backdoor Roth.

Unlike traditional IRAs and 401(k)s, Roth retirement accounts are funded with after-tax funds. The trade-off is that Roth distributions are completely tax-free upon reaching 59 1/2 years of age (so long as you’ve had an open Roth account for at least five years). Traditional IRA and 401(k) contributions, on the other hand, are tax-deductible while distributions are subject to income taxes.

Also unlike with a traditional IRA, Roth IRA holders are not required to take distributions at age 72. In fact, you don’t even have to take distributions during your lifetime; you can leave your Roth IRA to your heirs.

The process to transfer funds into a backdoor Roth IRA is simple. It typically involves paying a one-time tax on the amount to be converted. Because the transfer is considered income on that year’s taxes, some investors will do a series of backdoor Roth conversions over several years to avoid the additional income pushing them into a higher tax bracket.

However, it’s also possible to contribute pre-tax money to a traditional IRA and then, within the same tax year, convert that money to a Roth IRA without paying taxes on the conversion. In this case, you wouldn’t write off the contribution to the traditional IRA on your tax return.

It’s worth noting that a backdoor Roth IRA might not save you money in the long run. Depending on the associated costs and how long your investment will have to grow before taking distributions, a backdoor IRA conversion might not be right for you.