Backdoor Roth IRA Conversion

If you’re killing it income-wise this year and will exceed the income limits for a Roth IRA contribution, don’t fret. There’s a legal workaround to circumvent those income limits: a backdoor Roth IRA conversion.

Take the Backdoor

A backdoor Roth IRA conversion allows higher-earning taxpayers, those over the Roth IRA income limits and prohibited from contributing, to funnel money into a Roth IRA anyway. I coined this maneuver the ‘ole Roth IRA switcheroo over a decade ago, but the name never caught on. (I wonder why?)

The switcheroo funds your Roth IRA via a conversion rather than a contribution. Unlike direct Roth contributions, conversions have no income restrictions, creating a bit of a loophole, if you will. Contributing through the backdoor, however, has the same result as direct contributions: tax-free earnings accumulating in your Roth IRA.

401(k)-Type Plan Conversions

Don’t confuse what we are discussing here with a mega-backdoor Roth conversion. That’s different. It involves a workplace 401(k)-type plan and may or may not include a Roth IRA. I’ll leave that one for another newsletter.

IRA Conversions

You need both a Roth IRA and a traditional IRA to pull off a backdoor Roth IRA conversion. You’re allowed to have both. Just don’t exceed the yearly IRA contribution limits.

There are 2 types of contributions you can make to a traditional IRA:

1. Deductible Contributions – Deductible on your yearly income tax return. Principal and earnings are taxable upon withdrawal at ordinary income tax rates. You might have a traditional IRA with these types of contributions from the rollover of a 401(k)-type plan from a previous employer or direct contributions.
2. Non-Deductible Contributions – Unlike deductible contributions, there are no income limits for making non-deductible contributions to a traditional IRA, even if you or your spouse are covered by an employer retirement plan. However, as the name implies, tax must be paid on the contribution. Earnings grow tax-deferred and are taxable upon withdrawal and are not tax-free like in a Roth IRA. That’s why you want to convert them.

The IRS’ Pro-Rata Rule

A backdoor Roth IRA conversion doesn’t make much sense if you have existing deductible contributions in a traditional IRA. The pro-rata rule states you can’t cherry-pick which funds in your traditional IRA(s) you want to convert: You must convert a “pro-rata” portion of your non-deductible and deductible contributions.

For example, assume you’ve got $195,000 of deductible traditional contributions and earnings from your former employer’s 401(k)-type plan that you rolled over into a traditional IRA. Because you’re over the limits, you want to execute a backdoor Roth IRA conversion to your Roth IRA with a $5,000 non-deductible traditional IRA contribution.

97.5% (195/200) of the $5,000 conversion, or $4,875, would be subject to ordinary income tax because of the pro-rata rule. More than likely, the last thing you want to do is generate more ordinary income because of your already high tax bracket.

Executing a Backdoor Roth IRA Conversion

If you never had a traditional IRA or have one with no deductible contributions in it, you’re good to go as far as the conversion because there’s nothing to prorate. First, make non-deductible contributions to a new or existing traditional IRA, then immediately convert those contributions to your Roth IRA.

The idea is to convert it right away before any earnings are generated. If left in your traditional IRA, those earnings would be taxable at ordinary income rates upon conversion. Earnings accruing in your Roth IRA, however, will be 100% tax-free upon qualified withdrawal.

Unlike direct contributions to a Roth IRA, which are accessible at any time for any reason with no tax or penalty, converted money won’t be accessible tax and penalty-free until five years have passed since the conversion. Conversions made in different years all have distinct and separate five-year redemption windows. Of course, earnings must be left in your Roth IRA until you’re at least 59 1/2 to be tax and penalty-free upon withdrawal.

If you think the ‘ole switcheroo sounds a bit sneaky and underhanded, you’re not alone. You don’t want to make the IRS angry, right? Don’t worry about it. As of now, it’s 100% legal. Honest taxpayers have been performing backdoor Roth IRA conversions for over a decade with zero consequences.

Contribution Deadline

For 2026, you have until Tax Day, April 15, 2027, to make a 2026 IRA contribution. If you’re contributing between January 1, 2027 and April 15, 2027, be sure the custodian of your account knows the contribution is for 2026, not 2027. Assuming you haven’t already contributed for 2027, you’ll preserve your ability to contribute up to the IRA contribution limits.

Choosing a Custodian

You need a traditional IRA and a Roth IRA to perform a backdoor Roth IRA conversion. It’s best to hold them at the same financial institution or custodian. That will reduce the time and hassle of converting from one custodian to another.

If you want to move to a new custodian, do it via a trustee-to-trustee transfer or rollover. Open an IRA at your new custodian and they’ll help you roll over the old one and ensure your tax benefits are not lost.

Be sure your custodian offers free trades and low-cost indexed mutual funds and EFTs (exchange-traded funds). I recommend opening an account that has no broker association. Control your own money. Execute your own trades.

iShares®, Vanguard®, and Schwab® all meet the above criteria. There are others worthy of consideration. Look for the following:

• free trades and exchanges
• low expense ratios
• no other charges except the expense ratios

Investment-wise, you can keep it simple with my One-Stop Shop Investment Plan. Or, if you have the time and interest, you can get involved with more active investments.

A Beginners Guide….