Roth IRA Backdoor 2021

Learn how to contribute to a Roth IRA indirectly

A Roth IRA Backdoor is a common method used to contribute to a Roth IRA in a manner that would not necessarily be allowed using the direct approach.

Before getting into the specifics of a Roth IRA backdoor, it’s important to understand some of the basics on the different account types: Roth IRA, traditional IRA, Designated Roth, and retirement plans like a 401(k), 403(b) and 457. These will be quickly overviewed next. Though, if you’re already familiar with these account type, then you can skip directly to the Roth IRA backdoor specifics by clicking the following: What Is a Roth IRA Backdoor?

Roth IRA

A Roth IRA is a retirement account that accepts post-tax contributions. The max total contributions you can make to a Roth IRA in 2021 is $6,000 if under 50 and $7,000 if 50 or over. If you’re modified AGI is over $125,000 if single or $198,000 if married filing jointly, then you’ll only be able to contribute a reduced amount. If over $208,000 if married filing jointly or $140,000 if an individual, then you won’t be able to contribute at all directly.

Disbursements from a Roth IRA are fully tax free if they’re qualified. Also, there are no minimum distribution requirements for the original owner.

If you’d like to review the Roth IRA rules in more detail, then see the following: Roth IRA Rules

Traditional IRA

A traditional IRA is similar to a Roth IRA but has several notable differences:

  • Accepts pre-tax contributions. Note that if you have a retirement plan at work, then there are rules around the max pre-tax contributions you can make. See IRS - Effect of Modified AGI on Deduction if You Are Covered by a Retirement Plan at Work if interested.
  • Has minimum distribution requirements once you reach a certain age.
  • Pre-tax qualified distributions (both the original contributions and earnings) from a traditional IRA are taxed as regular income.

One other important note is that contributions to an IRA and Roth IRA both go to the same yearly max contribution limit. For example, if the max contribution is $6,000 and you had both a Roth IRA and traditional IRA account, then the combined total contributions to both accounts cannot exceed $6,000.

Designated Roth

Like a Roth IRA, a designated Roth’s contributions are post tax. Also like a Roth IRA, a Designated Roth’s disbursements can be tax free if they're qualified. Though, there are some notable differences compared to a Roth IRA:

  • A Designated Roth is separate account from a Roth IRA with different contribution limits.
  • A Designated Roth falls under another retirement plan like a 401(k), 403(b) or 457 whereas a Roth IRA does not.
  • Designated Roths require minimum distributions once you reach a certain age whereas Roth IRAs do not.
  • Designated Roths may have additional restrictions defined by the retirement plan like the investment options available whereas a Roth IRA does not.

Retirment Plans (401(k), 403(b) and 457)

Contributions to retirement accounts like a 401(k), 403(b), and 457 are made pre tax. Distributions from these accounts will be taxed when they are taken.

These plans are fully separate from a Roth IRA but may allow contributions to a managed Designated Roth. Note that the total contribution limit for the plan takes into account contributions for both the 401(k), 403(b), or 457 and the Designated Roth.

What Is a Roth IRA Backdoor?

A Roth IRA backdoor is a method by which one can contribute to a Roth IRA in a non-direct manner. Why would one want to contribute indirectly rather than directly? One of the most common reasons is that one cannot contribute directly due to the IRS’s modified adjusted gross income (AGI) cap for being eligible to contribute. Another is the annual contribution limits prevent direct contributions.

A Roth IRA backdoor is accomplished via a rollover from another account like a 401(k), 403(b), 457, or Designated Roth into a Roth IRA. When approaching it in this manner, you can legally get around the modified AGI and annual contribution limit requirements. To be clear, the IRS appears to be neutral on this topic. They neither advise against it nor advocate for it.

How to Transfer to a Roth IRA

There are three main ways to transfer from a given retirement account into a Roth IRA:

  • Same trustee transfer
  • Different trustees transfer
  • Rollover where the funds are sent to You

Of the three approaches, a trustee-to-trustee transfer is preferred. Additional details around the rules to transfer to a Roth IRA can be found at: Rules for Roth IRA Rollovers

Benefits of a Roth IRA Backdoor

There are a number of potential benefits to using the backdoor method including:

  • As already mentioned, it allows you to contribute to a Roth IRA if you do not meet the direct contribution requirements.
  • Roth IRA contribution earnings grow tax free.
  • Disbursements from a Roth IRA are tax free as long as they’re qualified.
  • A designated Roth requires minimum distributions once you reach a certain age. A Roth IRA does not have this requirement for the original owner.
  • The investment options can be less restricted under a Roth IRA.

Considerations around a Roth IRA Backdoor

While a Roth IRA backdoor can have a number of benefits, it should still be carefully evaluated to determine if it’s right for you. As part of this evaluation, there are some items to consider.

The first is that this isn’t a method to avoid taxes. If the source for the rollover to a Roth IRA comes from pre-tax contributions, then you will need to include the amount as income in your taxes for the year. This could potentially put you in a higher tax bracket.

Along with this, if taxes are to be pulled out of the transferred amount, then this means that you’ll be transferring an overall lesser amount into the Roth IRA than the original source amount. If the source amount was invested, then that means that you could potentially miss out on investment gains on the taxes paid that you would have otherwise gained over the years. You’ll want to balance this against the tax-free earnings of a Roth IRA to determine how this could impact your financial future.

Another consideration is the manner in which you perform the transfer. It’s best to do a direct trustee-to-trustee transfer. Otherwise, you could run into an additional 10% tax on the amount distributed (full amount for pre-tax distributions and earnings for post-tax distributions) in addition to other complications that may arise.

Additional Sources

If you’re looking for additional details around some of the topics discussed here, then they can be found at the IRS’s website at:

  1. IRS - Exceptions to Tax on Early Distributions
  2. IRS - Rollovers and Roth Conversions