BLOG #12
As a High-Income Earner, Did You Know You Can Still Do a Backdoor IRA?
If you’re a high-income earner, you may have already hit the income limits that prevent you from contributing directly to a Roth IRA. For 2024, individuals with modified adjusted gross incomes (MAGI) over $161,000 (or $240,000 for married couples filing jointly) are phased out from making direct Roth IRA contributions. But don’t worry—there’s a legal workaround: the Backdoor IRA.
What Is a Backdoor IRA?
A Backdoor IRA is a strategy that allows high-income earners to contribute to a Roth IRA, even if their income exceeds the limits. Here’s how it works:
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Contribute to a Traditional IRA: You first make a non-deductible contribution to a traditional IRA. There's no income limit for this, so anyone can contribute up to $7,000 annually ($8,000 if you’re over 50).
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Convert to a Roth IRA: After making the contribution, you immediately convert it to a Roth IRA. The key benefit of a Roth IRA is that your money grows tax-free, and you won’t owe taxes when you withdraw it in retirement.
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Pay Taxes on Gains: If the money in the traditional IRA has gained any interest or investment earnings before the conversion, you’ll owe taxes on that growth. However, if you convert quickly after making the contribution, there may be little or no gain to tax.
Key Considerations
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The Pro-Rata Rule: One important factor to consider is the IRS’s pro-rata rule. If you have other pre-tax funds in a traditional IRA, SEP IRA, or SIMPLE IRA, the pro-rata rule applies. This means you’ll owe taxes on a proportion of your total IRA balance, not just on the specific Backdoor IRA contribution, so careful planning is required.
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Contribution Limits: For 2024, the maximum IRA contribution (whether traditional or Roth) is $7,000, or $8,000 for those over 50. This is the total amount you can contribute across all IRAs.
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No Income Limits on Traditional IRA Contributions: Unlike a Roth IRA, anyone can contribute to a traditional IRA regardless of income level, which is why the Backdoor IRA is a viable option for high-income earners.
Why Consider a Backdoor IRA?
A Backdoor IRA offers significant tax advantages, especially for high-income earners who can no longer contribute directly to a Roth IRA. By converting to a Roth, you’ll enjoy tax-free growth on your investments, and qualified withdrawals in retirement will also be tax-free. It’s a great strategy to maximize your retirement savings in a tax-efficient way.
Pro tip: If you have existing pre-tax funds in a traditional IRA, consider converting them first or working with a financial advisor to minimize the tax hit. The pro-rata rule can significantly impact the tax benefits of the Backdoor IRA, so it’s essential to evaluate the full picture before proceeding.
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